Risk Arbitrage

AAA

DEFINITION of 'Risk Arbitrage'

A broad definition for three types of arbitrage that contain an element of risk:

1) Merger and acquisition arbitrage - The simultaneous purchase of stock in a company being acquired and the sale (or short sale) of stock in the acquiring company.

2) Liquidation arbitrage - The exploitation of a difference between a company's current value and its estimated liquidation value.

3) Pairs trading - The exploitation of a difference between two very similar companies in the same industry that have historically been highly correlated. When the two company's values diverge to a historically high level you can take an offsetting position in each (e.g. go long in one and short the other) because, as history has shown, they will inevitable come to be similarly valued.

INVESTOPEDIA EXPLAINS 'Risk Arbitrage'

In theory true arbitrage is riskless, however, the world in which we operate offers very few of these opportunities. Despite these forms of arbitrage being somewhat risky, they are still relatively low-risk trading strategies which money managers (mainly hedge fund managers) and retail investors alike can employ.

RELATED TERMS
  1. Reverse Cash-and-Carry-Arbitrage

    A combination of a short position in an asset such as a stock ...
  2. Arbitrage

    The simultaneous purchase and sale of an asset in order to profit ...
  3. Hedge Fund

    An aggressively managed portfolio of investments that uses advanced ...
  4. Leveraged Recapitalization

    A corporate strategy in which a company takes on significant ...
  5. Long (or Long Position)

    1. The buying of a security such as a stock, commodity or currency, ...
  6. Stub

    The balance part of a check or receipt that is retained for record-keeping ...
Related Articles
  1. Options & Futures

    Arbitrage Squeezes Profit From Market Inefficiency

    This influential strategy capitalizes on the relationship between price and liquidity.
  2. Options & Futures

    Are Derivatives Safe For Retail Investors?

    These vehicles have gotten a bad rap in the press. Find out whether they deserve it.
  3. Options & Futures

    Trading The Odds With Arbitrage

    Profiting from arbitrage is not only for market makers - retail traders can find opportunity in risk arbitrage.
  4. Investing

    What happens to the stock prices of two companies involved in an acquisition?

    When a firm acquires another entity, there usually is a predictable short-term effect on the stock price of both companies. In general, the acquiring company's stock will fall while the target ...
  5. Options & Futures

    The Basics Of Mergers And Acquisitions

    Learn what corporate restructuring is, why companies do it and why it sometimes doesn't work.
  6. Investing

    What are the risks associated with investing in telecommunication stocks

    Read about some of the risks associated with investing in telecommunication stocks, including several that are specific to the telecom industry.
  7. Active Trading Fundamentals

    What is liquidity risk?

    Learn how to distinguish between the two broad types of financial liquidity risk: funding liquidity risk and market liquidity risk.
  8. Stock Analysis

    Breaking Down the Halliburton Baker Hughes Deal

    Halliburton is using a downturn to get bigger and stronger in the long term, and the company is getting Baker Hughes at a reasonable price as a result.
  9. Active Trading Fundamentals

    What does the gearing ratio say about risk?

    Find out why lenders and investors pay close attention to a firm's gearing ratios, and why both too much and too little borrowing can be risky.
  10. Mutual Funds & ETFs

    What is the difference between a hedge fund and a private equity fund?

    Learn the primary differences between hedge funds and private equity funds, both of which are utilized by high net worth investors.

You May Also Like

Hot Definitions
  1. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  2. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  3. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  4. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  5. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
  6. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
Trading Center