Business Glossary

Business Definition for: risk arbitrage

Dictionary of Finance and Investment Terms

risk arbitrage

arbitrage involving risk, as in the simultaneous purchase of stock in a company being acquired and sale of stock in its proposed acquirer. Also called takeover arbitrage. Traders called arbitrageurs attempt to profit from takeovers by cashing in on the expected rise in the price of the target company's shares and drop in the price of the acquirer's shares. If the takeover plans fall through, the traders may be left with enormous losses. Risk arbitrage differs from riskless arbitrage, which entails locking in or profiting from the differences in the prices of two securities or commodities trading on different exchanges.

See also riskless transaction

Dictionary of Business Terms

risk arbitrage

arbitrage involving risk, as in the simultaneous purchase of stock in a company being acquired and sale of stock in its proposed acquirer; also called takeover arbitrage.

Related Terms:

riskless transaction

trade guaranteeing a profit to the trader that initiates it. An arbitrageur may lock in a profit by trading on the difference in prices for the same security or commodity in different markets. For instance, if gold were selling for $400 an ounce in New York and $398 in London, a trader who acts quickly could buy a contract in London and sell it in New York for a riskless profit.
concept used in evaluating whether dealer markups and markdowns in Over The Counter transactions with customers are reasonable or excessive. In what is known as the five percent rule, the National Association of Securities Dealers (NASD) takes the position that markups (when the customer buys) and markdowns (when the customer sells) should not exceed 5%, the proper charge depending on the effort and risk of the dealer in completing a trade. The maximum would be considered excessive for a riskless transaction, in which a security has high marketability and the dealer does not simply act as a broker and take a commission but trades from or for inventory and charges a markup or markdown. Where a dealer satisfies a buy order by making a purchase in the open market for inventory, then sells the security to the customer, the trade is called a simultaneous transaction. To avoid NASD criticism, broker-dealers commonly disclose the markups and markdowns to customers in transactions where they act as dealers.

Referring Terms:

arbitrage
riskless arbitrage
takeover
takeover arbitrage

Copyright © 2006, 2003, 1998, 1995, 1991, 1987, 1985 by Barron's Educational Series, Inc. Reprinted by arrangement with Publisher.
Copyright © 2007, 2000, 1997, 1987, by Barron's Educational Series, Inc. Reprinted by arrangement with Publisher.

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Business Definition for: risk arbitrage

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