Financial Glossary

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Arbitrage Arbitrage Asset Allocation Asset Allocation

Arbitrage

Let us tell you a story about a “Chaalu Chaiwala”! He was truly chaalu or shall we say, “Extra Smart”!! He would provide tea at Rs 5 per cup and his cost of preparing the same was Rs 4.Thus he made a profit of Rs 1.

But he was not happy with making a profit of just Rs 1.So he thought about he could increase his profit. It was then that he had a brainwave out of the blue! He identified a Government canteen which offered tea at Rs 2.

BIG IDEA! Wasn’t it? He could now simply buy tea for Rs 2 and sell it for Rs 5 and make a much better gain of Rs 3!

This buying of a thing in one market and selling in another market at a higher price is known as “Arbitrage”. Similarly if arbitrage opportunities exist, stocks too can be purchased in one market at a lower cost and sold in another at a higher cost.

So for the next few days, our Chaalu Chaiwala had a field day earning happily as he served his daily chai. But Alas! Such arbitrage opportunities do not last long. As information flow increases and the arbitrage opportunity gets known, it soon starts to disappear.

And this is exactly what happened in the case of our “chaiwala”. The chaiwala had an assistant who one day spilled the beans about the “arbitrage” advantage being enjoyed by the chaiwala. Soon after that, the chaiwala was rounded up and he confessed about the arbitrage opportunity he had spotted.

Since his customers, in a sense, had been paying a fair price all this while since Rs 5 had been the standard retail price in all canteens, the chaiwala was forgiven but was warned against adopting this practice again.

Thus it’s important to understand that “arbitrage” opportunities are short-lived. It is essentially a short window of opportunity that can be exploited by taking action at the right time. As information flow gets efficient, this opportunity vanishes as we saw in the case of the chaiwala. (Source: Tata Mutual Fund)
Asset Allocation

Asset Allocation is at the heart of personal finance. IT also means diversification.

Let’s look at an example to get some idea about diversification and how it helps?

Let’s look at the example of “Emirates”. It is one of the finest airlines and It also provides a very unique service

The different air-hostesses in the air-craft are proficient in different languages. Some speak French, some speak Mandarin, some speak Spanish, some speak Swahili, some speak Hindi depending upon the sector they fly.

How does this help?

Since it is an international airlines, it flies across the world and has passengers from all over the world

On some sectors knowing English alone does not work. Perhaps only French works in that sector. Hence the hostesses who speak French ensure that all is well. On some other sector perhaps knowing “Hindi” is essential and so on and so forth. Clearly different languages work in different sectors and having a staff knowing different languages ensures that all is well all the time

Similarly in investments, not all asset classes work at all the time. Hence if one were to invest all his savings in a single asset class then certainly it won’t be “all is well” all the time.

Therefore, it is prudent to invest in several asset classes such as equity, fixed income assets, gold , other commodities, real estate etc. because some asset class or the other will work for you by giving reasonable returns at all times, and all would be well at all times

Asset Allocation is therefore at the heart of “Finance Planning” It is the starting point towards designing your portfolio. (Source: Tata Mutual Fund)