Arbitrage

Definition: True arbitrage means capturing risk-less profits.

Arbitrage guarantees that prices in all markets are the same. Note: Arbitrage does not distort markets; it guarantees that they are consistent.

A good example of arbitrage is the currency market. A dollar can be bought with “Euros”, “Yen”, “Pounds” etc. So if you have a Euro and you want dollars you can buy dollars or you can use your Euro to buy Yen, use Yen to buy Pounds, and use Pounds to buy Dollars. Either way you’ll get 1.41 Euros for you dollar. Even as currency prices are constantly adjusting to news and trade flows prices are adjusting so that exchange rates are internally consistent.