Arbitrage-Free Valuation

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DEFINITION of 'Arbitrage-Free Valuation'

1. The theoretical future price of a security or commodity based on the relationship between spot prices, interest rates, carrying costs, convenience yields, exchange rates, transportation costs, etc.

2. The theoretical spot price of a security or commodity based on the futures price interest rates, carrying costs, convenience yields, exchange rates, transportation costs, etc.

When the actual futures price does not equal the theoretical futures price, arbitrage profits may be made.

BREAKING DOWN 'Arbitrage-Free Valuation'

Cash-and-carry trades, reverse cash-and-carry trades, and dollar roll trades are all examples of trades made by arbitrage traders when theoretical and actual prices get out of line. Of course, setting up and executing such trades is complex. For the trade to be truly risk free, variables must be known with certainty and transaction costs must be accounted for. Most markets are too efficient to allow risk-free arbitrage trades.

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RELATED FAQS
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    Arbitrage is basically buying in one market and simultaneously selling in another, profiting from a temporary difference. ... Read Full Answer >>
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  3. Is there a difference between financial spread betting and arbitrage?

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>
  4. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
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