Arbitrage

Arbitrage - the practice of buying a product at a low price in one market and selling it at a higher price in another market - is as old as trade. A basic business maxim is: “Buy low and sell high.” Knowledgeable middlemen, knowing the prices of products in different parts of the world, would buy from producers in one region and sell to consumers or merchants in another region. One motivation for the exploration of the New World was the con- trol of land-based trade by merchants in the Middle East. European businesspeople and monarchs knew that new distribution channels would reduce the power of arbitrageurs.
Arbitrage is based on information. With today’s global communications systems, the opportunities for arbitrage are both fewer and greater. In financial markets, arbitrageurs simultaneously buy and sell securities, commodity contracts, and currency contracts in two markets, with profits based on slight differences in prices in the markets. For example, currency exchanges operate in many countries around the world. The major currency markets are in New York (New York Mercantile Exchange - NYMEX) and London. If the U.S. dollar was being traded at a rate of $1.4225 dollars per British pound in New York and $1.4220 in London, an arbitrageur could buy British pounds in London and sell British pounds for U.S. dollars in New York, earning a small profit ($0.0005) on the exchange. Five-hundredths of a penny is not much money, but when trading millions of dollars and British pounds, there is potential for profit. Increased access to global markets increases opportunities for arbitrage but also increases market knowledge, reducing disparities in market prices.
Arbitrage occurs in more than just financial securities and international trade. Internet auction sites are helping to bring together buyers and sellers, providing vast amounts of market information and opportunities for businesspeople using this resource. For many years classic cars have sold at a premium in California. Entrepreneurs often purchase cars in other parts of the country, hoping to sell them at a premium in the Golden State. Now automobiles, boats, and all kinds of products are being sold over the Internet.