The mutual funds industry is a hotbed for innovation. Over a
period of time, it has come up with varied products satiating
the needs and requirements of investors with different
risk-return-liquidity profiles. The Indian mutual funds industry has
kept close pace with the developments happening across the world.
The period from mid-1990s till date has been very eventful for the
Indian mutual funds industry. This period has witnessed many new
things —new players, new processes, new regulations and lots of
new products. The latest in the list is arbitrage funds.
An arbitrage opportunity is an investment strategy
that guarantees a positive payoff in some contingency, with no
possibility of a negative payoff and with no net investment. A simple example
of arbitrage is to borrow and lend at zero transaction cost at
two different fixed rates of interest. Arbitrage limits the possibilities
for the price of a product to differ by more than the transaction
cost. Arbitrage in the financial markets, more accurately known as
risk arbitrage, does not involve simultaneous sale and purchase of
the same securities. Arbitrage opportunities in the securities
markets come from the fact that there are many ways to trade the
same asset, and many different assets are influenced by the same
factors.
Scenario I shows the movement of the stock price above the settlement price. Let us assume
that the stock is trading at Rs. 1,200 on the date of settlement. At this point, the price of ABC stock in
the cash market and the futures market will be the same. So, when the investor sells the stock,
a profit of Rs. 200 is earned and at the same
time, he also needs to buy the futures contract to
close the position, thus incurring a loss of Rs.
150. Therefore, a net profit of Rs. 50 is earned. |
