After reading this article you will learn about Arbitrage:- 1.
Arbitrage is a technique of making profit on stock exchange trading through difference in prices of two different markets. If advantages of price are taken between two markets in the same country it is called domestic arbitrage.
Sometimes, arbitrage may also be between one country and another. It is called foreign arbitrage. Such an advantage in prices between two countries can be taken when the currencies of both the countries can be easily converted.
Arbitrage usually equalizes the price of security in different places. When the security is sold at a high price in a market, more of the supply of the security will tend to bring a fall in the price, thus neutralizing the price and making it equal to the price in the cheaper market.
On placing an order, the brokers get busy through different kinds of trading activities, which may also include options and other speculations such as wash sales, rigging, cornering, blank transfers or arbitrage. The speculators in the stock market are generally represented by bull, bear, stag and lame duck.
A bull is a person on the stock exchange who expects a rise in the price of a certain security. A bull is also called a tejiwala because of his expectation of price rise. The usual technique followed by a bull is to buy security without taking actual delivery to sell it in further when the price rises. The bull raises the price in the stock market of those securities in which he deals. He is said to be on the long side of the market.
If the price falls (since there is no actual delivery) the bull pays the difference at a loss. The bull may thus close his deals if the price continues to fall or carry forward the deal to the next settlement day by paying an amount called contango charge.
The bull may carry forward his deal if he expects a price rise in the future which will cover the contango charge and also bring him profit. Thus, active bulls in a stock exchange put pressure in a stock market and raise the price of the security. The increase in prices is generated through bulk purchasing of securities.
Example of Bull Transaction: A person asks his broker to buy for him 500 shares at Rs. 10 each for which there is no immediate payment. Before he pays for the shares on the date of settlement, the price of shares rises by Rs. 5 per share. He would instruct his broker to sell the shares on his behalf. The transaction may not be real. Only the difference may be paid for on the date of settlement.
A bear is the opposite of a bull. He expects a fall in prices always. He is popularly known as Mandiwalla. He agrees to sell for delivery, securities on a fixed date. He may of may not be in actual possession of these securities. On the due date, he purchases securities at a lower price and fulfils his promise at a higher price. In this way, he makes a profit on a transaction which may be real or notional with settlement of difference only.
The bear makes a loss if the price rises on the date of delivery. In such a situation, he will have to buy at a higher price and sell at a lower rate in fulfilment of his agreement. The share market usually shows a decline in price when bears operate and sell securities not in their possession.
On the date of settlement, the bear has an option either to close the deal or carry it forward by an amount called the backwardation charges. If the bear is able to make a profit on the settlement date, it is called cover because the bear buys the requisite number of shares and sells them at a specified price on the delivery date.
A person expects a fall in the price of shares of a company. He may agree to sell 500 shares at Rs. 15 each on a specified date. If before the fixed date the price of the shares has failed to Rs. 12 he makes a profit of Rs. 3 per share, as calculated below is total profit on 500 shares:
When the price is rising and the bulls are active in the market, there is buoyancy and optimism in the share market. The market in this situation is reigning bullish. Where there is decline in prices, the market is said to go bearish. This is followed by pessimism and decline in share market activity.
The bulls begin to spread rumors in the market about rise in prices where there is an over-bought condition in the market, i.e., the purchases made by the speculators exceed sales made by them. This called a bull campaign. Similarly, a bear raid is a condition when speculative made by bear speculators exceed the purchases made by them and they spread rumors to bring the price down.
A bear cannot always keep his commitments because the price does not move the way he wants the shares to move. He is, therefore, said to be struggling like a lame duck.
A bear may agree to sell 500 shares for Rs. 15/- each on a specified date. On the due date, he may not be able to settle his agreement for scarcity or non-availability of security in the market. When the other party insists on delivery on that date itself, the bear is said to be a lame duck.
A stag is a cautious speculator. He does not buy or sell securities but applies for shares in the new issue market just like a genuine investor on the expectation that the price of the share will soon rise and be sold for a premium.
The stag shares the same approach as a bull, always expecting a rise in price. As soon as the stag receives an allotment of his shares, he sells them. He is, therefore, taking advantage in the rise in price of shares and is called premium hunter.
The stag does not always make a profit. Sometimes public response is not extraordinarily good and he may have to acquire all the shares allotted to him and he may have to sell at a lower price than he purchased it for when the stag sells at a discount he makes a loss. The market also suffers a decline. The stag is not looked upon with favour.
It is a method with which a person protects himself against loss. A bull agreeing to purchase a security for someone may hedge or protect him by buying a put option so that any loss that he may suffer in his transaction may be offset.
Similarly, a seller can hedge against loss through call. After the order has been placed on the broker and the various instructions have been given to him so that he can execute the order in the market, the broker asks his customer for a margin.
Management,Investment Management,Stock Exchange,Arbitrage
Before publishing your articles on this site, please read the following pages:
Career Development in HRM: Meaning, Need, Stages and Methods
Employee Training: Objectives, Process, Steps and Methods
Controlling Function of Management: Meaning, Importance, Process and Need