Concept of Arbitrage

In Business Language, the purpose of the arbitrage is to enter into a set of financial obligations to get profits with no risk. It is usually done by taking advantages of differences in the interests rates, exchange Rates or commodity prices between one market to another if the rates of both the markets are known and if the profits to be gained are outweighing the costs of operation. That is why, arbitrage is non-speculative. Regarding risk in arbitrage, please note that in principle and in academic use, an arbitrage is risk-free; in common use, as in statistical arbitrage, it may refer to expected profit, though losses may occur, and in practice, there are always risks in arbitrage, some minor (such as fluctuation of prices decreasing profit margins), some major (such as devaluation of a currency or derivative).

Example of Arbitrage:

We suppose that the exchange rates in London are £5 = $10 = ¥1000 and the exchange rates in Tokyo are ¥1000 = $12 = £6. Converting ¥1000 to $12 in Tokyo and converting that $12 into ¥1200 in London, for a profit of ¥200, would be arbitrage. In reality, this “triangle arbitrage” is so simple that it almost never occurs. But more complicated foreign exchange arbitrages, such as the spot-forward arbitrage (see interest rate parity) are much more common. ^{(More examples you can find on Arbitrage entry of wikipedia)}