Tuesday, June 1, 2010

What is Arbitrage?

My latest post, which happened to involve food, got more visits and acclaim than my typical posts.  In fact, one reader explicitly said that food based finance was more accessible.  So, let's try it again.

The term arbitrage is common in the finance industry.   Performing arbitrage is profiting from the variance in prices in the market.  Take the vanilla bean example in my last post.  Imagine that the big grocery store had a really liberal return policy, and they would let me "return" vanilla beans with or without the original container at the price of $16 for 2 (the price they sell them).  I could go to the local spice shop, buy 10 beans for $20, and then go sell them to the grocery store for $80.  I keep the $60 as profit and have successfully arbitraged. 

This helps explain why many stores require a receipt and/or original packaging to accept returns.


  1. okay, okay, thank you. BUT what's the actual application of this term? who actually does this?

    please also post soon and explain to me why i should invest my money. here's my reasoning: if i keep it in a savings account, it is safe and secure in there and nothing can happen to it. but if i invest it, maybe the great depression will come and my money will be gone and i'll have to wear cardboard boxes on my feet. your take?

  2. I actually used this term while chatting with my friends about options for our long distance baby shower. A friend suggested that I could return the items to the stores in MI and re-buy them in MA with coupons to get an additional discount. I said, "Hey, that's arbitrage!" I feel bound by ethical factors in this situation, but I wonder if that is realistic.