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Arbitrage Funds - A deep dive

By HARSH AGARWAL

10th Jun 2022

2 mins read

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With the first sip of chai, a thought pops up in your mind... let's sell biscuits. Your friend gives you the deadliest look and bursts into laughter. Anyways, you convince him to listen to your plan of buying the biscuits from a wholesale market at a lower cost and selling it in your shop at a competitive one. The idea suddenly seems feasible to you and your friend, and you dream of your biscuit empire. The last sip of tea reaches your throat, and the empire's plans get postponed to another meeting.

We all had such dreams that most of us couldn't realise. Worry, not an investment instrument provides you with a similar opportunity! Stay with us while we give you a roadmap to your biscuit empire...

What is an Arbitrage Fund?

Arbitrage funds exploit the rate difference of an equity share in different markets. This rate difference forms the basis of returns of such funds.

How do these funds work?

While the arbitrage funds can work in various ways, the simplest one would be exploiting the price differential across multiple stock exchanges. E.g. - A stock trades at ₹100 in NSE and ₹102 at BSE. Now, a fund manager can buy the share in NSE and sell it in BSE, earning a risk-free profit of 2%.

In addition to this, the fund managers also use derivatives to generate risk-free returns.

The role of fund managers

To generate sweet returns in these types of funds, the market's price differential opportunities must be identified. The fund managers are responsible for identifying these same opportunities in a volatile market. The fund managers also ensure that assets are invested in highly rated debt instruments to keep these investments safe.

Benefits

  • Low-Risk Returns

These funds are a way to generate low-risk returns as these mostly work in price differential in the equity market. Furthermore, these funds also invest in debt instruments, making them even safer. Thus, these funds can be a viable alternative to other market-linked funds for someone with a lower risk appetite.

  • Exit Loads

These funds mostly come with a negligible exit load and a low exit load period. Thus, investors can look at these funds as an alternative to liquid funds.

Things to consider

  • Taxation

These funds are taxed like equity funds with a 15% tax on the short-term capital gain.

  • Lower Returns

Although risk-free, these funds give a considerably lower return than other equity funds.

This was some information regarding the arbitrage funds, a roadmap to your biscuit empire. We'll be back with another blog with some other finformation.

Till Then, Stay Safe! Invest Safer!

Q) What is the derivative market?

Ans. The derivative market derives its prices from an underlying asset. Futures and options are derivatives that are traded in the stock market.

Q. How are debt instruments rated?

Ans. There are various institutions that rate a debt instrument, the most popular one of which would be CRISIL. They rate a debt instrument from AAA to D, with AAA being the highest and the safest and D being the scum of the barrel. They use various sector dependent methodologies to arrive at these ratings.

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