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Understanding Arbitrage: An Intuitive…

Understanding Arbitrage: An Intuitive Approach to Financial Analysis

by Randall Billingsley

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The Foundation of Fair Markets

Arbitrage is the foundation of fair financial markets. As a consumer, I become irritated when I find a product I have recently purchased, selling for less than I just paid. As an investor when the same thing happens, I feel cheated and question the validity of a system which allows such discrepancies to exist.

Arbitrage promotes market efficiency. In its essence, it identifies mispricings and develops strategies to exploit them. Yet, it is more. When understood in the classical sense, it provides the foundation for valuation. Randall S. Billingsley, a finance professor at Virginia Tech, weaves technical detail with intuitive financial thought to produce a well-written, easily understood discussion of how arbitrage relates to capital structure analysis.

In seven short chapters, he takes the reader on a sweeping tour of this age-old art and science of riskless, self-financing transactions. In his exploration of the topic, he:

1. Explores the core concepts in arbitrage analysis.
2. Illustrates the nature of arbitrage using several examples.
3. Introduces the concept of “cost-to-carry.”
4. Shows how arbitrage influences currency exchange rates.
5. Explains put-call parity.
6. Reveals arbitrage as the foundation of option pricing.
7. Posits that despite financial claims, real assets determine a firm’s value.

This book is a treasure. It will guide both professionals and students who wish to understand the often arcane concepts and mathematical foundation of arbitrage. ( )
  PointedPundit | Mar 25, 2008 |
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