| Definition |
Simultaneous buying and selling of an asset in different markets to profit from price differences. |
Strategy to reduce or eliminate the risk of adverse price movements in an asset. |
| Primary Objective |
Earn risk-free or low-risk profits from market inefficiencies. |
Minimize potential losses by offsetting risk exposure. |
| Risk Level |
Generally low risk, but depends on execution speed and market conditions. |
Risk reduction; may limit potential profits as well. |
| Instruments Used |
Stocks, bonds, commodities, currencies, derivatives. |
Derivatives like futures, options, swaps; sometimes insurance contracts. |
| Market Conditions |
Relies on price discrepancies across markets or securities. |
Applicable in volatile or uncertain market conditions to manage risk. |
| Time Horizon |
Usually short-term trades to capture temporary price gaps. |
Medium to long-term strategies depending on risk exposure. |
| Profit Potential |
Profit is generally limited to the price difference; can be consistent if repeated. |
Profit is secondary; primary goal is loss prevention. |
| Cost |
Costs include transaction fees, bid-ask spreads, and capital requirements. |
Costs include premiums on options, margin requirements, and transaction fees. |
| Examples |
Buying gold cheaper on one exchange and selling at a higher price on another. |
Farmers using futures contracts to lock in prices and reduce crop price risk. |
| Impact on Portfolio |
Can increase returns with minimal risk if done correctly. |
Reduces portfolio volatility by offsetting risks. |
| Complexity |
Requires advanced knowledge of multiple markets and fast execution. |
Requires understanding of risk management and derivative instruments. |
| Regulatory Concerns |
Generally legal but requires compliance with market rules; some forms may be restricted. |
Widely accepted and encouraged for risk management. |
| Use by Investors |
Commonly used by institutional traders, hedge funds, arbitrageurs. |
Used by corporations, investors, and fund managers to protect against risk. |
| Relation to Speculation |
Less speculative, focusing on exploiting inefficiencies. |
Not speculative; intended as a defensive strategy. |
| Outcome if Market Moves Favorably |
Profits from price differences regardless of market direction. |
Profit opportunities may be sacrificed for protection. |
| Financial Exposure |
Typically requires capital but limited exposure due to simultaneous trades. |
Exposure is managed by offsetting positions. |
| Liquidity Requirement |
Requires highly liquid markets to enter and exit quickly. |
Depends on liquidity of hedging instruments. |
| Psychological Impact |
Focus on precision and speed to capitalize on short windows. |
Focus on risk management and peace of mind. |
| Summary |
Arbitrage exploits price differences for profit with minimal risk. |
Hedging reduces or eliminates risk exposure to protect against adverse price moves. |
Arbitrage vs Hedging