Give an example of an arbitrage opportunity?  

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william1941 | College Teacher | (Level 3) Valedictorian

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Arbitrage is the ability to make a risk-free profit by using the price mismatch of an entity in different markets or the mismatch of prices between commodities that can be traded for each other.

For an example consider the foreign exchange market: you find that with 1 Euro you can buy $1.5, and with $1 you can buy 100 Yen. But the number of Yen that can be bought with 1.5 Euro is not 150 but 145. So now you invest $1 to buy 100 Yen. Use the 100 Yen to buy 100/145 = .6896 Euro and use the .6896 Euro to buy $1.0344. So you have been able to make a 3.44 cent profit for a dollar by just utilizing the mismatch in price of the Yen and the Euro.

Whenever arbitrage opportunities arise these are spotted immediately and as people try to use them for their gains the prices quickly re-align to equilibrium levels due to the supply and demand.

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