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Chapter 1

Introduction

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1.1 Introduction of the study

A central idea in modern finance is the law of one price. This states that in acompetitive market, if two assets are equivalent from the point of view of risk 

and return, they should sell at the same price.

If the price of the same asset is different in two markets, there will be

operators who will buy in the market where the asset sells cheap and sell in the

market where it is costly. This activity termed as arbitrage, involves the

simultaneous purchase and sale of the same or essentially similar security in

two different markets for advantageously different prices.

Theoretical arbitrage requires no capital, entails no risk and appears to be an

easy way of earning profits. However, real–world arbitrage calls for large

outlay of capital, entails some risk and is a lot more complex than the

definition suggests. A major weak link in India’s financial sector today is

inadequate knowledge about arbitrage..

1.2 Object of the study

Part of Masters of Business Administration curriculum to have practical

exposure to the actual competitive environment.

1.3 Objective of the study

• To know the concept of arbitrage.

• To observe arbitrage trading practically.

• To know how to earn risk free profit.

1.4 Rational of the study

Arbitrage trading related to NSE & BSE stock exchange.

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1.5 Limitation

• While doing the study proper information was not given as they have to

concentrate on the market trading.

• Theoretically the concept is very easy to understand but practically its very

tuff.

• The time span for studying the concept is very less.

 1.6 Definition

An arbitrage opportunity is the opportunity to buy an asset at a lower price

then immediately selling it on a different market for a higher price.

1.7 Meaning

In an economics and finance, arbitrage is the practice of taking advantage of a

 price differential between two or more markets: combinations of matching

deal are struck that capitalize upon the imbalance, the profit being thedifference between the market price. When used by academics, an arbitrage is

transaction that involves no negative cash flow at any probabilistic or temporal

state and a positive cash flow in at least one state; in simple terms, a risk-free

 profit. A person who engages in arbitrage is called an arbitrageur. The term is

mainly applied trading in financial instruments.

If the market price do not allow for profitable arbitrage, the prices are said to

constitute an arbitrage equilibrium or arbitrage-free market.

1.8 Arbitrage is possible when one of three conditions is met

The same asset does not trade at the same price on all markets ("the law of one

 price").

Two assets with identical cash flows do not trade at the same price.

An asset with a known price in the future does not today trade at its future

 price discounted at the risk-free interest rate (or, the asset does not have

negligible costs of storage; as such, for example, this condition holds for grain

 but not for securities).

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Arbitrage is not simply the act of buying a product in one market and selling it

in another market for a higher price at some later time. The transaction must

occur simultaneously to avoid exposure to market risk, or the price may

change on one market before both the transaction are over. In practical terms,

this is generally only possible with securities and financial product which can be traded electronically.

1.9 Requirement

True arbitrage requires that the financial instrument is trading at two different

 prices, and that buying and selling trades can be completed at the same time.

The simultaneous trade requirement is designed to eliminate any risk in

holding a trade. Trades based upon the same principles as arbitrage might be

 buying a commodity in one location, transporting the commodity to another 

region, and selling the commodity in a new region. This type of trade would

not be true arbitrage, because the buying and selling trades would not have

occurred at the same time.

Example:

Stock and stock futures- buying a stock and selling a single stock future

contract.

Stock on different exchanges- buying a stock on one exchange and selling thestock on another exchange.

Mergers- buying the stock of a company being acquired, and selling the stock 

of the acquiring company.

1.10 Operation pattern of Arbitrage

In situation where it is possible to exploit mispricings risk less by generating

 perfectly hedged positions and holding on to them till the final payoff, the

following operational aspects need be noted before implementing arbitrage

strategies:

For the arbitrage to be risk-free process, the arbitrager must trade simultaneously in

two markets.

• All trading involves transaction costs. 

• But not all mispricings are profitable arbitrage opportunities.\

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1.11 Existing arbitrage opportunities

The launch of the derivative markets in India has given rise to a whole new

world of arbitrage. Multiple products with the same underlying asset are now

available for trading. Mispricings across the spot, futures and options markets

can led to profitable arbitrage opportunities.

1.12 How is arbitrage done

In situations where it is possible to exploit mispricings risk less by generating

 perfectly hedged positions and holding on to them till the final payoff, the

following operational aspects need be noted before entering into an arbitrage.

For the arbitrage to be a risk–free process, the arbitrageur must tradesimultaneously across two markets. In efficient markets, arbitrage

opportunities last for very short periods. As arbitrageurs spot these

opportunities and act upon them, the arbitrage gets wiped out. The fastest

instances of arbitrage opportunities being wiped out, are those seen in the

stock exchange market. This market trades shares in large volumes, so what

seems like a small mispricings can often translate into huge profits.

Example:

Reliance’s June stock future was quoting at Rs 1954.70, and this was at asignificant premium to its cash price of Rs 1964.40 to the extent of Rs 9.70.

This amounted to a huge cost of carrying. The arbitrager who was sure that

apart from the pure demand and supply factors in the cash and future market,

there is no reason, for the stock futures to exhibit such a wide difference. He

chose the risk-free arbitrage to cash in on the gains. Thus, he sold Reliance

futures in the future segment and bought Reliance stock. By the time the

futures approached expiry, the difference vanished, when he sold the shares

and squared off the position. By this act, he earned a huge risk-free return even

after taking into account his costs of transaction.

Trading involves transactions costs. These transactions costs and other market

imperfections create a no– arbitrage band around the fair value of an asset.

Hence the arbitrage opportunity must be sizeable enough to generate a profit

over and above the costs involved. Not all mispricings are profitable arbitrage

opportunities.

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1.13 Transaction rates in arbitrage

Cash to cash

+1000 buyed

-1000 sold

 

Cash to future

+1000 buyed

-1000 sold

Future to future

+1000 buyed

-1000 sold

And if the turnover exceed Rs 1, 00, 00,000(1crore) the interest

charged on it is Rs 1700/-

The transaction costs involved are brokerage, service tax on  brokerage, securities transaction tax (STT), Demat charges,

derivatives clearing charges.

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0.30

0.23

0.35

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1 .14 How the transaction does from NSE to BSE or vice-versa takes

place?

Firstly it is not possible as such for a layman or a beginner.

There are possibilities to do trades with some condition.

a) DELIVERY SELLING.

If you have your shares in your DEMAT account. You can sell it in NSE as well

as BSE, wherever it is beneficial to you irrespective of the fact that whether you

have bought those shares from NSE or BSE.

Condition :- You MUST have those shares in your DEMAT a/c

Your Broker Must be a member of Both Exchanges i.e. NSE and BSE

 b) ARBITRAGE with shares

In this case, When you have certain amount of shares in your DP. Then firstly

you sell those shares in One Exchange (suppose) NSE and buy it Back on the

other one i .e BSE.

Condition: -

You MUST have those shares in your DEMAT a/cYour Broker Must be a member of Both Exchanges i.e. NSE and BSE

The price difference is good enough to account for the charges that our levied on

Buying and selling in Delivery mode.

c) ARBITRAGE without shares.

This is interesting one. It requires a HAWK eye as a trader. You need to SPOT a

shares with good enough Volume in both Exchanges.

 

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Lets understand this with an Example

SHARE of ABC Ltd trading at 44.25 in NSE

SHARE of ABC Ltd trading at 43.85 in BSE

You BUY 1000 shares of ABC from BSE @ 43.85 per share

You SELL 1000 shares of ABC from NSE @ 44.25 per share

 NET POSITION is N I L

now wait for the fluctuation to turn in you favour. Now Suppose after two hours

of trading

SHARE of ABC Ltd trading at 46.15 in NSESHARE of ABC Ltd trading at 46.20 in BSE

You closes your position i. e

You SELL1000 shares of ABC from BSE @ 46.20 per share

You BUY 1000 shares of ABC from NSE @ 46.15 per share

Profit / Losses made by you

 NSE :- Loss of 1.90 per share (46.15 - 44.25)

BSE :- Profit of 2.35 per share (46.20 - 43.85)

Therefore NET Profit made by you is 0.45 (2.35 - 1.90) per share

Gross Profit = 1000 x 0.45 = 450

 Normally These Trades are done with GREATER Volume i.e. 20,000 onwards.

Well the profits may be small in terms of per share but risk are relatively low

than mere INTRA DAY Trade without logic. When it’s done with good

volumes, gives HANDSOME Profits. As all trades are INTRA DAY therefore

the brokerage Charges are nominal.

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1.15 Difference between intraday and arbitrage

1.16 Why common public can’t do arbitrage?

For doing arbitrage license is required which is provided by SEBI. There is

special exam for arbitrage after passing it u gets the license. Then u get code

for login to current market and then only u can do arbitrage. Not all brokers

have the authority/facility to be arbitrageurs.

Common public can’t do inter exchange settlement of funds…

For common public arranging large fund is very difficult...

1.17 Risks in arbitrage in India :

The basic principles of an arbitrage strategy are straightforward- if an assest trades at

two different prices across two markets, buy where it trade cheap and sell where it

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It is done in single exchange {BSE or 

 NSE} at a time.

It is done in both exchanges at a same

time.

There is no limit for loss. risk is high Loss is of fixed amount. So it is less

risky

Up & down in market has significant

effect

It is not affected by sudden rise or fall

in market

Intraday can be done in many scripts Arbitrage is done only in script which

are listed on both the exchange

Tips are given for intraday No tips are required for arbitrage

Common public can do intraday Common public can’t do arbitrage as

they don’t have license for it.

Code is not required for doing intraday Without code arbitrage is not done

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trades expensive.. in reality, almost all arbitrage requires capital and carries some

risk.

What are the risks?

The first risk is the trade execution risk. While all care is taken while executingtrades, there is a difference in the price at which trades finally gets executed and the

 price that is targeted at the time of initiation of the trade. These differences arise on

account of various reasons such as overload on trading system of the exchange,

sudden price volatility, connectivity speed etc.

Mark to market risk typically arises in rising markets because additional margin is

required to be given to the derivatives clearning member. This may turn out to be

more than money kept aside. However in such a situation one can reverse the original

 position and avoid margin payment.

Risk on clearing corporation and members is the risk of the exchange or itsclearing corporation defaulting. However this is similar to the risk of bank 

going bankrupt and mainly theoretical.

Connectivity to the exchange, natural disasters etc. pose a risk since the trader 

need to be reversed on or before expiry of the contract. In case we are unable

to reverse the position on or before expiry of the future contract on account of 

loss of connectivity or natural calamity or fire, it market result in losses.

1.18 Required knowledge

Arbitrage requires an understanding of the price mechanisms across markets.

Most market players in India are not yet comfortable about trading on the

derivatives market. Even those acquainted with derivatives market do not

understand the intricacies of arbitrage. This lack of knowledge results in

sustained mispricings on the market.

1.19 Trading restrictions:

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Chapter 2

Industrial Profile

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2.1 INDUSTRY PROFILE

A ) Early Years: - 

The Indian broking industry is one of the oldest trading industries that has

  been around even before the establishment of the BSE in 1875. Despite

  passing through a number of changes in the post liberalization period, the

industry has found its way towards sustainable growth. With the purpose of 

gaining a deeper understanding about the role of the Indian stock broking

industry in the country’s economy, we present in this section some of the

industry insights gleaned from analysis of data received through primary

research.

For the broking industry, we started with an initial database of over 1,800 broking firms that were contacted, from which 464 responses were received.

The list was further short listed based on the number of terminals and the top

210 were selected for profiling. 394 responses, that provided more than 85%

of the information sought have been included for this analysis presented here

as insights. All the data for the study was collected through responses received

directly from the broking firms. The insights have been arrived at through an

analysis on various parameters, pertinent to the equity broking industry, such

as region, terminal, market, branches, sub brokers, products and growth areas.

B) Geographical Concentrations: -

Almost 52% of the terminals in the sample are based in the Western region of 

India, followed by 25% in the North, 13% in the South and 10% in the East.

Mumbai has got the maximum representation from the West, Chennai from

the South, New Delhi from the North and Kolkata from the East.

Mumbai also has got the maximum representation in having the highest

number of terminals. 40% terminals are located in Mumbai while 12% arefrom Delhi, 8% from Ahmedabad, 7% from Kolkata, 4% from Chennai and

29% are from other cities in India.

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Fig.1

C) Products Offered: -

The survey also revealed that in the past couple of years, apart from trading, the firms

have started offering various investment related value added services. The sustained

growth of the economy in the past couple of years has resulted in broking firms

offering many diversified services related to IPOs, mutual funds, company research

etc. However, the core trading activity is still the predominant form of business,

forming 90% of the firms in the sample. 67% firms are engaged in offering IPO

related services. The broking industry seems to have capitalized on the growth of the

mutual fund industry, which was pegged at 40% in 2006. More than 50% of thesample broking houses deal in mutual fund investment services. The average growth

in assets under management in the last two years is almost 48%. Company research is

another lucrative area where the broking firms offer their services; more than 33% of 

the firms are engaged in providing company research services. Additionally, a host of 

other value added services such as fundamental and technical analysis, investment

 banking, arbitrage etc are offered by the firms at different levels.

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D) Future Plans

68% of the firms from the sample have envisaged strategies for future growth. With

the middle class Indian investor as well as foreign investor willing to invest in the

stock market, majority of the firms preferred expansion of institutional and the

Foreign Institutional Investor clients in their areas of growth. Around 84% have

shown interest in expanding their institutional client base. Nearly 51% of such firms

are located in the West, 25% in North, 15% are from South and 9% from East. Since

the past couple of years, India, along with Korea and Taiwan, has been one of the

  preferred destinations for the FIIs. With corporate restructuring, rising market

capitalization and sectoral friendly policies helping the FIIs, more than two thirds of 

the firms are interested in increasing their FII client base. Amongst these firms, west

again has maximum representation of 53%, followed by North with 22%. South has

15% firms and East makes up for 9%.

Fig 2

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Chapter 3

Company Profile

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Chapter 4

Research Methodology

4.1 RESEARCH METHODOLOGY

During my project, I collected data through various sources primary & secondary.

Primary data:-

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Primary data is the data which is not available. This data is especially collected

which is known is first hand data

Primary sources:-

•

Questionnaires for public

• Discussion with experts

• Live trading in the market

Secondary data:-

Secondary data is the data already collected by someone else. This data is not

especially collected to solve present or specific problem. The information is relevant

and can be used for our purpose

There are two major sources of secondary data collection

They are:

Internet

Reference book (N. Sridhar)

 

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Chapter 5

Data Analysis, Findings

&

Interpretation

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21

SCRIP BSE (Rs) NSE (Rs) Diff. (Rs)

ABB 695.4 692.1 3.30

ACC LIMITED 764.0 763.1 0.90

AMBUJA CEMENTS 96.2 95.8 0.45

AXIS BANK 739.1 738.3 0.85

BHARTI AIRTEL 782.3 777.7 4.65

BHEL 1,984.7 1,986.0 -1.30

BPCL 450.9 452.3 -1.40

CAIRN INDIA 212.5 212.7 -0.25

CIPLA 262.1 262.5 -0.40

DLF LIMITED 278.6 278.5 0.10

GAIL 311.2 311.4 -0.20

GRASIM 2,401.9 2,402.8 -0.85

HCL TECH. 177.4 176.7 0.65

HDFC 2,199.2 2,198.5 0.65

HDFC BANK 1,386.1 1,378.9 7.25

HERO HONDA 1,447.9 1,452.3 -4.40

HIND. UNILEVER 266.5 267.4 -0.85

HINDALCO 73.1 72.8 0.30

ICICI BANK 629.0 628.9 0.10

IDEA CELLULAR 67.4 67.6 -0.25

INFOSYS 1,726.5 1,721.2 5.35

ITC 210.5 210.6 -0.10

JINDAL STEEL 2,539.9 2,540.0 -0.10

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Source of data:- This data is collect from secondary

source(www.moneycontrol.com))

Chart 1

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Interpretation of data:-

As shown in the chart1 the various companies script trading in NSE and BSE have

some difference in their rates at both the exchanges, but as correctly mentioned above

that every mispricings is not an opportunity because here the carry cost or borrowing

cost of the company matters a lot or may vary.

As shown in the script of RELIANCE there is the difference of Rs 3.25 though there

is the difference the company having high carrying cost or borrowing cost cannot grab

the opportunity.

Fig.3

Here as we can see the difference in the rate the arbitrage company cannot grab the

opportunity at the period(stages) of 1,2,3 because of borrowing cost pr carrying cost

 but the company can take or grab the maximum opportunity on 5,6 stage of the chart

shown above….

This also shows the volume in this share is quite large so the rates keep onfluctuating(volatile) and as a result the opportunity can be grab easily.

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Fig.3.1

While doing the summer project one day the rate of the script RELIANCE was

observed that there was not much of difference between two markets or we can say

the volatility was not there. So there was not much of opportunity to grab in for the

arbitrageur 

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Chapter 6

Findings

&

Suggestions

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Finding

1) Cost cutting

For doing arbitrage firm requires large capital. Firms need finance for short term for 

doing arbitrage; therefore they take loan from investor. Therefore, caring cost per unit

increases. Investor give their money for 1month or two months on interest or 

sometimes they invest money on profit/loss bases i.e. 50% sharing in profit and lost.

So it’s necessary to reduce the cost of caring for firm.

While doing summer project I came across that company had borrowed funds from

investor on 1% interest rate per month. Therefore, there caring cost had increased by

1% more. 

 E.g   . reliance industries current market price is 1800{bse} caring cost of company

becomes {18rs (int) +2rs (charges)} =20rs we can clearly see that we want 

difference of 20rs in BSE & NSE to come at break event point...

 In daily trade its observe that this script shows difference of 6 to 7rs therefore, we

can say firm can make profit by doing 4 to 5 times such trade with difference of 6rs

at least in a month..

 2) Ambience

Ambience plays an important role because the atmosphere of the surrounding should

not be dull because they have to be alert for garbing the opportunity.

In company chairs where very close many times it disturbed the person sitting on

screen.

The area was near about 700sqt in which 20 people have to work with their different

screens and to and fro of any person disturbed the operator.

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 3) Idea of Arbitrage funds

As there are various intermediaries in market who are directly or indirectly related to

the capital market for mobilizing their resources and getting maximum return.

For making concept real one company came up with mutual fund wherein they collectthe money from the public and make optimum use of capital in market with a view of 

making profit. But as rightly said by DHIRUBHAI AMBANI

‘PROFIT DON’T REQUIRE ANY INVITATION’ but the mutual fund company

only understands the language of profit. In other words they have their margin in

 profit but they don’t share in loss incurred by customer 

  4) Training of Technical analysis

As per the observation done during the project, I observed that the employees wait for 

the arbitrage opportunity to take place and then work on that according, till the time

the employee cannot grab the optimum opportunity available

  5) Technology

One of the problems faced during the project by the company was like;

E.g.:

As every table has couple of screen on the table but one of their college was

facing a technological problem. The rates of the script were getting changed but the

time taken by this p.c was mainly delayed by near about 5sec. Means the screen was

updating the rates after 5 sec (late). So the time span of 5 sec is a very long time as the

deals are done in secs. So the loss can be occurred.

6) Payment

The salary plays an important role for an every individual working. But in an

arbitrage though the employees are working for the top management but they don’t

have any restriction for doing any kind of transaction. The job of arbitrage is very

much beneficial for the employees if they get the right amount of payment because

arbitrage requires lot of experience and alertness for trading.

The company was currently sharing their payment in the ratio of 30:70, though

the company was earning profits so the employees were a bit dissatisfied.

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Conclusion

Arbitrage is a fascinating process. Theoretically, an arbitrage opportunity is

like money lying on the road waiting to be picked. The trick of the trade is in being able to spot the opportunity quickly.

Besides an understanding of the markets, the processes and the risks involved,

exploiting arbitrage also requires capital and infrastructure. In some markets it

is possible to detect and capture arbitrage profits manually. Doing an arbitrage

trade today is fairly simple. However, as derivatives get more complicated, the

 procedures employed for doing arbitrage will steadily get more complex. This

will require new skills to be developed and new processes to be formulated.

With the introduction of multiple new products, faster trading mechanisms and

more efficient markets, it may prove to be impossible for the human eye to

detect or act upon arbitrage. We would then have to rely on computers. As

computers get into the game, arbitrage opportunities would be quickly wiped

out’s

There would however always be smart operators who would find ways to use

new products and new markets in order to continue the arbitrage game.

Capturing an arbitrage opportunity involves following prices in two markets

and entering into trades simultaneously on both these markets. Successful

arbitrage depends on obtaining the correct prices across the two market and

trading accordingly. Due to the lack of adequate IT infrastructure, prices 20

from various agencies are often received with a time lag.

The delay can sometimes be as long as 30 seconds. This implies that what

may appear like a potential arbitrage opportunity at time T may actually have

existed at time (T-t) and may or may not exist anymore. Having proper 

decision support systems in place will help to correctly identify and exploit

arbitrage across markets.

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Recommendation

Suggestion 1:

Company should try to reduce rate of interest or should try to convince

investor to be 50% partner in profit and loss. This will increase the

opportunity of company to earn more profit.

Suggestion 2:

For doing comfortable arbitrage there should be near about 1200sqt for the

accommodation of at least 20 members.

Company should provide comfortable sitting.

Refreshment activities like playing of songs

Suggestion 3:

On other side concept of arbitrage is of earning risk free returns. So people

should be made aware of arbitrage so that they can invest their money in

arbitrage where risk is low and chances of profit are 90%. Company should

come up with the awareness about arbitrage.

People are mostly interested in earning the returns. As rightly said people have

lots of fund in their pocket but how to take them out is a big challenge for 

everyone, here arbitrage can be successful.

The crux of arbitrage is ::markets are no doubt the riskiest of all other asset

class like gold, real asset…etc,, but to reduce the risk in the market to the

maximum and gain a decent return out of it, is what arbitrage is all about. Its

 just catching and enchasing the rate differences in two exchanges making it a

lot more less riskier investment decision to earn money compared to any other 

asset class.

  Suggestion 4:

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Training should be conducted by the firm after the market time trading

is over because on the job training is not possible.

As they are well experienced, have good speed of typing, good eye sight etc an

technical training may add a value to their trading and also help them to

motivate as they can work more effectively and as a result company can take

maximum opportunity of the profit.

Suggestion 5:

To avoid this company should:

Set a particular team should by the company for looking upon the technical

aspect.

Regular check up of p.c should be taken into consideration after the time of 

market trading is over 

Some inventories of spare parts related to the computers should be maintained

(especially keyboards)

Use of only and only BOLTS and NEAT system should be taken to prevent

delay in rates refreshing

Suggestion 6:

Company should give or share their profit in the ratio of 50:50 to all the

experienced employees working. (The payment or sharing ratio was same for 

everyone)

Company should also look upon the job satisfaction rather then their profits

 because experience employees are rare to find.

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Chapter 7

Bibliography

Magazines:

⇒ Capital Market

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⇒ Dalal Street

⇒ Bank Quest

Websites:

⇒ www.intra.rathi.com

⇒ www.icicibank.com

⇒ www.rbi.org.in⇒ www.moneycontrol.com

⇒ www.equitymaster.com

⇒ www.nseindia.com

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Chapter 8

  Ann

exure

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ANNEXURE

A survey of 100 clients is conducted in gandhi securities ltd. And data

collected from the survey is as follow:-

QUESTIONNAIRE

Name of the person:-

 __________________________________________________________ 

Address:-_________________________________________________________________ 

Phone No:-______________________________ E-Mail:-__________________ 

1) Do you know the concept of arbitrage?

yes

no

2) Do you know any other investment except cash & f&O?

 YES

NO

 

3) Do you think arbitrage investment is beneficial for you?

 Yes

No

May be

4) Are you interested in risk free returns?

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 Yes

No

5)what Amount of investment would you like to invest in arbitrage ?

10000

10000 to 100000

Above 100000

Source of data:-

This data is collected from primary source i.e. with the help of questionnaire.

Interpretation of data:-

01)

Here the chart represents that nearly 95% of the people doesn’t know the

concept of arbitrage. Only 5% of the people are aware of the concept of 

arbitrage.

Fig 4

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no

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02)

 This chart indicates that 95% people don’t know any other investment

rather than cash market or future market and only 5% are aware of the

other investment.

Fig 5

03) This chart indicates that the investment in arbitrage may be

beneficial for them as the concept is not clear in their minds. The percent

of people who thinks it will not be beneficial is near about 20%, the

people who thinks its beneficial is near about 10%, and the people who

think it may be beneficial is near about 70%

yes

no

maybe

Fig6

04)

this pie chart enable us that the people who are interested in risk free profit are near about

95% and the remaining 5% are not interested as they like to deal in speculative market and

earn there profits though they are risky but they don’t have patience to wait.

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yes

no

Fig 7