Question

Answer these questions:

1. Explain why it is so difficult to make arbitrage profits.

2. Benefits of remaining unhedged?

3. Identify and how to calculate arbitrage opportunity

4. Challenges to shareholder value maximization

Answer 1

1. Arbitrage refers to making of profits by purchase and sell of securities in different markets. With technological advancements, it is very difficult to make arbitrage profits as the computerised systems track the slightest change in price of a security or similar securities. The corrections are made very fast and thus the opportunity to make arbitrage profit is eliminated.

2. Hedging is employed by corporations to eliminate / reduce risk level in any transaction/operation.

For example- an exporter in India who has amount receivable in $ in future might hedge his risk by getting $ conversion fixed at a certain rate such that if the value if INR strengthens , he will receive a predetermined amount in INR. But if INR falls against $, he would lose an opportunity to earn a higher profit.

Thus remaining unhedged leads to higher profits if the conditions are favourable. Moreover the hedging cost would get eliminated if a person remains unhedged.