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ARBITRAGE IN THE STOCK MARKET

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ARBITRAGE IN THE STOCK MARKET
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Abhijeet S
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ARBITRAGE IN THE STOCK MARKET - September 13th, 2010

IN THE STOCK MARKET


ARBITRAGE OPPORTUNITY ARISES WHEN THE SAME SCRIP TRADES AT DIFFERENT PRICES IN DIFFERRENT MARKETS.


IN SUCH A SITUATION INVESTORS BUY THE STOCK IN ONE MARKET AT A LOWER PRICE & SELL IT IN THE OTHER FOR MORE,CASHING ON THE NET DIFFERENCE, NET OF TRANSACTION COST.


ARBRITAGE OPPORTUNITY VANISHES QUICKLY AS INVESTORS RUSH IN TO TAKE ADVANTAGE OF THIS PRICE DIFFERENCE.


THUS ARBRITAGE HELPS CORRECT THE DISCREPANCIES IN PRICING.




INDEX FUTURES

BEING A DERIVATIVE PRODUCT INDEX FUTURES DERIVE THEIR VALUE FROM THE STOCKS THAT CONSTITUTE THE INDEX.


INDEX FUTURES VALUE IS LINKED TO THE STOCK INDEX VALUE THROUGH THE OPPORTUNITY COST OF FUNDS REQUIRED TO PLAY IN THE MARKET.



E.G
STOCK INDEX VALUE=1200

OPPORTUNITY COST OF FUNDS =10%

THEORETICAL VALUE OF A 3 MONTHS FUTURES INDEX =1230.

THIS IS EQUIVALENT TO INVESTING RS1200 IN THE UNDERLYING SCRIPS AT THE MARKET RATE OF 10% FOR 3 MONTHS.

THE STOCK INDEX VALUE IS COMPOUNDED AT THE OPPORTUNITY COST OF CAPITAL FOR THE NUMBER OF DAYS REMAINING IN THE CONTRACT ,TO ARRIVE AT THE THEORETICAL INDEX FUTURES VALUE.




FOR SPOTTING AN ARBRITAGE OPPORTUNITY THE INVESTORS SHOULD LOOK AT THE FOLLOWING

STOCK INDEX VALUE.

THEORETICAL INDEX FUTURES VALUE.

ACTUAL INDEX FUTURES VALUE.


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