05-22-2008, 04:08 PM | #1 |
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Can you smart guys explain to me
some fundamental principles of arbitrage.
What are the fundamental assumptions? From what very little I know it involves the exchange of interest rates, but perhaps that's too simplistic. Are there any good reads on the subject?
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05-22-2008, 04:14 PM | #2 | |
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Before I could get to reading their stuff though they had lost billions and caused some real financial panics in the late 90's. I then decided I would just resign myself to the fact that I could never figure it out. |
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05-22-2008, 04:16 PM | #3 | |
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Can you at least explain some of the theories.
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05-22-2008, 04:20 PM | #4 |
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http://en.wikipedia.org/wiki/Arbitrage
example, you bet on BYU +5, the line moves to BYU even. at that point you bet against BYU. if there are no transaction costs, you break even if BYU loses by more than 5 or wins, but you win if BYU wins by 1-5. |
05-22-2008, 04:24 PM | #5 | |
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This part is what concerns me.
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05-22-2008, 04:24 PM | #6 | |
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Stock X is being bought out at $40 a share. However it is currently trading at $39.50. An abitrager will step in and buy the stock at $39.50. He will have to factor in how long before the deal closes and the interest he could have made on the $39.50 vs the .50 gain. It can get a lot more complicated when you have supposed imbalances in currencies, interest rates, futures , etc. |
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05-22-2008, 04:27 PM | #7 |
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IIRC (and it's been a few years now), if you believe in an efficient market, then arbitrage doesn't exist, or at least it is nearly impossible to correctly identify arbitrage opportunities and realize a gain on them.
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05-22-2008, 04:29 PM | #8 | |
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And if any party fails to perform and you have borrowed money, you're screwed?
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05-22-2008, 04:32 PM | #9 |
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Where some of them have gotten out of control is when they think they have developed some super cool model. When the yen does such, interest rates do such. When oil does such, foreign currencies do such and on and on. These models can get very complicated.
If they work the difference you pick up is small, but done at such a grand scale you make huge sums of money. If it is working they can acquire more investors capital and even get banks to loan money and bet margin. At one point I think Long Term Capital had $6 billion of investor money in the deal and over $130 billion in borrowed money. Here is how something could come unraveled. Take my simple Stock example. Arbitrager buys at $39.50. He also borrows to do it because the numbers work out and the more he has the better .50 a share will make him. Hic cup occurs. Buying company has an SEC problem. Deal falls apart. Stock now at $35 a share and margin calls are coming. The more he gets margin calls, the more stock he is forced to put on the market and the stock falls further. Eventually he loses all his money and a lot of the lenders money. |
05-22-2008, 05:15 PM | #10 | |
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