Arbitrage: Riskless Profit

Andrew had received an email from a friend in Bonn that a Trexi action figure there is at 60 deutschmark in one store. Andrew loves collecting these action figures made in Singapore. And in Cologne, all shops as Andrew patiently called each week had Trexi action figure at 80 deutschmark.

And so after he made many correspondences, his friend agreed to buy 10 of these action figures and send them over to Andrew through another mutual friend who was going to Cologne. Andrew did not even need to pay for a courier since a friend was to hand-carry them.

A week later, Andrew knew that his new schoolmate Friedrich was also into collecting Trexi. Since his collection had a double because of some careless purchase years ago, he decided to sell the duplicate to Friedrich. Being all too familiar with the prices in Cologne, Andrew sells it to Friedrich at 75 deutschmark. The new schoolmate agreed. That is a 15 deutschmark profit to Andre.

A few days after later another schoolmate Andrew is not very familiar with approached him and asked if he is selling Trexi action figures at 75 deutschmark. An idea then sprung to life. Andrew replied to him later to see if any of his collections can be sold. Before he could even leave the school premises, another one asked him to sale a Trexi action figure.

Immediately upon arriving home, he contacted his friend over at Bonn for the availability of Trexi action figures. The reply was positive. So he wrote back to send him another 10 figures. And since Wilhelm would not be able to transport the toys, he paid for a courier service.

When they arrived, he sold to two schoolmates who asked for them. Soon news about him selling Trexi spread and there were more buyers. And soon the ten new action figures were gone. Because of the courier service the profit per piece was reduced to 12 deutschmark.

What Andrew is doing is called arbitrage and Andrew can be called an arbitrageur. It is the process of buying or selling something in order to exploit a difference in price so as to make a shielded profit. On each toy he sells the profit gained is equal to the price differential. The bigger the price differential the more profit and hence the greater incentive to trade.

During the second delivery of the toys a courier was employed but still it did not discourage Andrew from trading further. The cost is small relative the transactions involved.

For as long as the gap between price differentials are not narrowed, the incentive to trade by arbitrage is very profitable. And if the transaction cost does not overpower the profit, arbitrage will prosper.