Risk Assessment
You're flying a glider toward the gaping maw of a volcano. From a mile away, you can already feel the heat. You see a giant bubble of lava puke from the lid. You do a risk assessment and decide that you want to go home to your washboard stomached pool boy instead of flying forward.
The same transformation happens in the investing landscape. Buying a stock trading at 10 times earnings, which pays a 5% dividend, and you're likely not taking all that much risk (and you won't get much reward). Buy a stock at 40x next year's notional earnings, if it in fact ends up growing revenues 200%, and you're taking a ton of risk. If they miss, their stock gets cut in half.
You have to assess the risks and the timeframes, and think about where you want to roll your dice.
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Finance: What is Arbitrage?22228 Views
finance a la shmoop what is arbitrage? not yourbritage or mybitrage but
arbitrage what it's been a while since we conjugated anything around here oh ok [Man talking about arbitrage]
so moving on arbitrage is a riskless trade you make guaranteed profits just
for being on top of things or in the right place at the right time or you're
there when opportunity comes a-knockin think about the stock exchanges in the [Men working in stock exchange]
pre-internet era around the world communication well it was relatively
slow and expensive back then especially when it came to sharing data one [Man talking into olden microphone]
relatively easy arbitrage or riskless trade opportunity that came about was
when stocks traded at one price on the various european exchanges versus the
prices it traded at on the US exchanges like shares of IBM might have been [Share price graph of IBM]
offered for sale at $165 32 cents on the london stock exchange even net of
currency conversion prices remember the Brits were on the pound system but in
the US investors were paying $165 47 cents a share
so an easy 15 cents a share was made all day long in buying the shares of IBM in
London and then just selling him back here in New York well both sides of the
trade were made at the same time it was riskless it was arbitrage and arbitrage
became a whole industry for a while until the capital markets went to work
and spreads tightened as communication got more liquid and people sprayed a [Spreads word becomes narrower]
bunch of wd-40 on information passing around the world and then that 15 cent [15 cents transfers from US to England]
spread from London to New York became more like a penny or a tenth of a penny
or at least close enough of a spread so that it was no longer worth bothering to
try and make a buck or a billion whatever those arbitrageours made in
those days