8 Arbitrage

This video introduces the concept of arbitrage, clarifying that it differs from mere investing or buying low and selling high. Arbitrage exploits mispricing in assets, often generating risk-free profit by effectively producing value from nothing. You'll learn why mispricing occurs, such as when fundamental financial principles are violated. The tutorial then demonstrates how to construct a simple arbitrage portfolio through a practical example involving differing discount rates, illustrating how to achieve a positive cash flow with zero initial net investment. The video details an example where a two-year discount rate is lower than a one-year rate, violating the fundamental principle that a dollar today is worth more than a dollar tomorrow. This specific mispricing allows for the construction of an arbitrage portfolio by borrowing at the cheaper two-year rate and simultaneously lending at the higher one-year rate. This strategy results in a guaranteed future profit without any initial cash outlay. Alternatively, the video shows how to achieve an immediate positive cash inflow at time zero without any future repayment obligations. The discussion consistently emphasizes that genuine arbitrage stems from asset mispricing, not simply an increase in asset value over time. Subscribe to @AxiomTutoringCourses for more insights into financial concepts.