ARBITRAGE 1. What is arbitrage?—Arbitrage, or as it is some times called, indirect exchange, is a term applied to any transaction which takes advantage of differences of prices for the same article in different markets. Arbitrage is thus defined in the Century Dictionary: "The calculation of the relative value, at the same time at two or more places of stocks, bonds or funds of any sort, including exchange, with a view to taking ad vantage of favorable circumstances or differences in payments or other transactions." This definition should include gold and, in a general sense, any other commodity. Wheat, for example, may be sent from one place where it is relatively cheap to another where it is relatively dear; this is arbitraging in wheat. High prices in one market induce shipments from markets with low prices and this process constantly tends to equalize prices generally.
2. When arbitrage is transacted.—Arbitrage trans actions are confined entirely to large financial centers, such as London, New York and Paris. The work calls for expert knowledge and a close study of finan cial conditions, as it is essential that the arbitrageur keep in daily, if not hourly, touch with his foreign correspondents, in order that they will be prepared to carry out a transaction without delay.
A recent article in the New York Financier says : In conducting such operations it is essential that the banker shall be advised, thru the cable, of the varying con ditions of the markets abroad. In such markets as Paris and London, where the exchange transactions are always large, rates often fluctuate sharply and conditions change frequently. Consequently, tho the situation may be favor able one day it may suddenly become adverse, necessitating some modification of the method of arbitraging. Moreover, it frequently happens that after a successful negotiation has been effected by a banker as the result of private infor mation, his competitors may be advised of the favorable con ditions prevailing and they also may draw in a similar man lier. Hence each operator seeks to obtain for himself alone all possible information regarding changes which are likely to affect his business. Sometimes a banker may find, upon calculation, that it will be profitable to conduct arbitraging of exchange between three or more points ; in such cases the conditions at each of the points must first be ascer tained and calculations have to be made with the utmost care. Occasionally in drawing bills the banker, in order
to take advantage of arbitraging operations, will transfer credits, thru the cable, from an adverse center to a point favorable for his purpose. Indeed there are very many ways by which arbitraging can be profitably conducted by bankers having the requisite facilities and the necessary skill for such operations. It will he observed that operations in arbitraging of exchange require the services of men of the largest experience, and hence the business can be con ducted to advantage only in the most thoroly equipped offices. The exchange student who enjoys opportunities for practice in such offices and has the determination to qualify himself for this branch of exchange work by acquiring a knowledge of all of its intricate details will have no diffi culty after such qualification in securing advancement. The field for operations in arbitraging of exchange is continu ally and rapidly broadening, and there will probably always be a demand for the services of men capable of taking posi tions as mananrs of exchange houses or departments.
3. Parity.—A parity is the price at which a bill should be quoted in order to compare it with the quo tations for similar bills elsewhere. To make this com parison it is of course necessary to express every quo tation in a common form. Care must also be taken to bring quotations for long bills to a demand basis, by allowing for stamps and interest.
If the New York parity on Paris is 5.1895 as against the actual rate of 5.16% in New York for Paris checks, an opportunity for arbitrage profit of 2.07 centimes per dollar is offered. On $100 this amounts to 40 cents, and on $48,754.56 to S195. Bankers who engage in arbitrage transactions gen erally construct a parity table for ready reference be tween the more important exchanges. The following is an example of such a table, showing parities in dol lars, francs and sovereigns. Similar tables may be made for sterling, marks and dollars, for francs, marks and dollars, etc.