International Arbitrage: Benefits and Limitations

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Table of Contents

Introduction
Arbitrage
Benefits and Advantages of Arbitrage
Disadvantages of Arbitrage
Purpose of Arbitrage
Types of Arbitrage
Applicability of Arbitrage
Conclusion
References

Introduction

International arbitrage deals with taking advantage of variation in prices of commodities. It is popular among business people but different from other business practices because the practice of buying and selling takes place relatively at the same time. Arbitrage is a process of buying and selling which takes place almost at the same time but in different markets. The people involved in this practice normally aim at getting their benefits in terms of profit from the variation in prices of commodities in different markets (Investopedia, 2012).

Arbitrage totally depends on market inequality in prices therefore investors will focus on those markets where they are likely to reap more profits from the sales they make. This practice is greatly considered safe by many investors since to them it is a shield from incurring losses. This is because buying of a commodity never takes place until the prospective buyer becomes certain that a profit is available. It is however important to note that international arbitrage is normally affected in cases where communication breakdown is experienced. This is because the process entirely relies on a good communication network.

Arbitrage

After putting money in business, arbitrage guarantees an investor zero exposure to loss and the same investor is guaranteed handsome benefits in terms of profit. Arbitrage practiced in the business world is divided into three: “pure arbitrage, near arbitrage, and speculative arbitrage” (Damodaran, n.d., p. 2). Pure arbitrage involves little or no risk at all and the investor gets a lot of profit. Near arbitrage involves a situation where an investor is in possession of commodities whose value is similar or relatively similar and there is little indication that the difference is to be achieved.

Speculative arbitrage is a practice of selling commodities which are not well priced but almost perform same purpose. The investors here normally buy the assets which are relatively cheaper and sell those that are more expensive (Arbitration Associates, n.d.). Among the three categories, two of them are easily practiced in the business world. Pure arbitrage is not easily practiced mainly because; “identical assets are not common in the real world, especially if you are an equity investor” (Damodaran, n.d., p. 3).

Benefits and Advantages of Arbitrage

One of the main benefits of arbitrage is the fact that it examines the misunderstandings affecting investors with an aim of solving them. This is because arbitrage does this without being bias to any of the parties involved. This ensures that the investors are not scared of any inequities in case a dispute arises between two or more investors. The solving of these disputes is made easier by the fact that it is conducted by locally internal judicial system. This idea is legally supported by agencies such as the United Nations thus making it more promising to business people (Bradgate & White, 2011).

It is also easy to monitor variation of prices of commodities in different markets because arbitrage is highly computerized. The benefit here is that investors are able to avoid making purchases which will expose them to incurring losses. As mentioned earlier, arbitrage heavily relies on reliable communication network. With the emergence of the internet, business people are able to access the relevant information they need. This enables them to avoid markets which may expose them to losses especially as a result of fluctuation in commodity prices (Essvale Corporation Limited, 2008).

In case of a dispute which may require court intervention, arbitrage has avenues which ensure that the resolution is arrived at faster. This means that the outcome of such a case does not become a stumbling block to the progress of the parties involved. In cases where many people are involved delays are inevitable but compared to normal court procedures it is takes relatively less duration of time in arbitration.

Solving of disputes which may arise during the arbitrage process is cheap in terms of cost incurred. The fast speed with which these disputes are solved saves money which could have been used in cases where more time is spent. Just as mentioned above, it is important to note that “…….there can be exceptions due to multiple parties, lawyers, arbitrators and litigation strategy” (Mazirow, 2008, p. 3).

In terms of defense, there is no much exposure to destruction. This ensures that the parties involved in a dispute are not taken through a long process which at the end may proof futile. Investors are therefore motivated to do their business without fear because they are assured of a process almost similar to a judicial one but far much better.

Once an arbitrage award has been ruled in favor of an individual, they are assured of getting it without delays which may otherwise be caused by delays as there is no room for appeal. This saves on time which could have been spent pursuing appeals. It also makes the judges to be extra careful while passing judgment to avoid cases whereby some of the parties involved may feel unfairly judged. A situation like this will also ensure that they win confidence from the people they represent. People will therefore be careful and observe the treaties which govern arbitrage (Romeo & Dye, 2008).

Disadvantages of Arbitrage

In a situation where an arbitrator makes a wrong ruling the person who is not favored by the ruling suffers harm since there is no room for appeal. Although there are exceptions to which the rulings may face, it is equally difficult to state the difficulties. arbitrage cases are said to be fact driven and this makes it extremely difficult to follow up a case in which somebody feels that they were not given a fair hearing (Ballard, 2007). Another demerit of arbitrage is that it is not always fast and there are cases where the process is expensive. Failure by an arbitrator to give an award based on regulations of law or evidence may be a big set back to the process of arbitration. This may cause unfair benefits to some people and as injustices to others (United Nations Conference on Trade and Development, 2005).

Purpose of Arbitrage

Arbitrage is mainly aimed at joining economic activities and conditions to make the activities to be carried out in a proper manner to prevent unhealthy competition. It was mainly established to ensure the rules governing these activities are followed and as a way of protecting investors from exploitation. It has managed to achieve this by establishing “specialized institutions of arbitrage (which) can acquire and use informational advantage over general courts of civil law” (Dominguez, 1972, p. 6).

Another purpose of arbitrage is to provide justice and security to investors through putting in place treaties which must be conventionally agreed upon by all the parties. arbitrage is based on concurrence to ensure that personal justice is put in place. This means that if the parties involved do not agree upon then there should be re-negotiation to the treaties.

Types of Arbitrage

There are several types of arbitrage. Forex arbitrage- involves little or no risk at all; investors use it in an open currency exposure (Essvale Corporation Limited, 2008). Another type is the statistical arbitrage which gives traders an opportunity to make profits based on variation among securities. The third type of arbitrage is merger arbitrage which involves stocks of various firms being incorporated and whatever is acquired sold for purposes of making profit. The last type of arbitrage is known as convertible arbitrage; it is a form which allows the buying and selling of commodities and later converting it to get profits.

Applicability of Arbitrage

Arbitrage is greatly applicable in the world today because it heavily relies on communication. Today we have advanced communication all over the world. This allows those involved in arbitrage to get the relevant information needed to promote this process.

Conclusion

International arbitrage is a practice which is used to make profits by investors. The practice requires wide connectivity and constant updating of information on the trend of the changes in the prices of goods in various markets. It may be equated to predatory buying and selling as it depends on one’s ability to take advantage of the variations in the market prices of goods in various markets. When practicing arbitrage therefore one needs to be sure of the pricing of commodities at the various markets where the commodities will exchange hands.

References

Arbitration Associates: Types of Arbitration: A Short and Simple Description of Arbitration in an easy to Understand Format, n.d. Web.

Ballard, L. F. (2007). ABCs of Arbitrage: Tax Rules for Investment of Bond Proceeds by Municipalities. Chicago, IL: American Bar Association.

Bradgate, R & White, F. (2011). Commercial Law. Web.

Damodaran, A. (n.d.). Arbitration. Web.

Dominguez, J. R. (1972). Devaluation and Futures Markets. Lexington, MA: Prentice Hall.

Essvale Corporation Limited: Business Knowledge for IT in Trading Exchanges, 2008. Web.

Investopedia: Definition of Arbitrage, 2012. Web.

Mazirow, A. (2008). The Advantages and Disadvantages of Arbitration as Compared to Litigation. Web.

Romeo, P & Dye, A. (2008). Section 16 Desk book. San Francisco, CA: Executive Press. California.

United Nations Conference on Trade and Development: Dispute Settlement: International Commercial Arbitration, 2005. Web.

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