What characterizes pure arbitrage?

• A. An opportunity that carries significant market risk
• B. An opportunity that involves negligible risk
• C. An opportunity requiring high capital investment
• D. An opportunity that is time-sensitive

Answer: (B)

Pure arbitrage is characterized by the ability to exploit price discrepancies in different markets or forms of an investment with negligible risk involved. This typically occurs when an asset is simultaneously bought and sold in different markets at different prices, allowing the arbitrageur to lock in a profit without exposure to market risk. The essence of pure arbitrage is that it is risk-free in theory, as the transactions are designed to offset each other.

In practice, while all trading entails some risk, pure arbitrage seeks to minimize or eliminate risk during the execution of the strategy by ensuring that the two positions taken offset each other completely. This distinct lack of exposure to market risk is what fundamentally defines pure arbitrage compared to other trading strategies that may carry some level of risk. Additionally, pure arbitrage opportunities are often limited in duration, as market forces tend to correct price discrepancies quickly once they are identified, which leads to the perception of being time-sensitive, but this is not intrinsic to the concept of pure arbitrage itself.

The focus of pure arbitrage remains on negligible risk, making it an appealing strategy for those looking to exploit market inefficiencies with little chance of loss.