What is Arbitrage and difference between Cash price and Future Price

*What is Arbitrage and difference between Cash price and Future Price*

🎯 *What is Arbitrage*

📌Arbitrage describes the act of buying a security in one market and simultaneously selling it in another market at a higher price, thereby enabling investors to profit from the temporary difference in cost per share.

📌An arbitrage fund is a type of mutual fund that appeals to investors who want to profit from volatile markets without taking on too much risk. This schemes look to exploit the price difference between spot and futures market to earn risk  free returns.

🎯 *Why is there gap between cash price & future price*

📌Stock futures have a monthly expiry cycle and expire on the last Thursday of every month.

📌In stock-futures arbitrage you buy in the cash market and sell the same stock in the same quantity in the futures market. Since the futures price will expire at the same price as the spot price on the F&O expiry day, the difference becomes the risk-free spread for the arbitrageur. 

📌Futures price pertain to a contract that is 1 month down the line there is a cost of carry; also, roughly known as the interest cost. So, let assume,  if the annual risk-free rate of interest is 12% then the 1-month future's price must be at a 1% (12%/12) premium to the cash price. Of course, in reality the futures price is determined by a variety of other factors, but this is the key factor. Therefore, by buying in the cash market and selling in the futures you lock in that 1% returns per month.

📌For example of CYZ stocks Cash price 28th June 2020 100, while 28th July, Future price is 101. So,the Arbitrage spread is {(101-100)/100}, which is 1% that is return of 30 days. So annualised return in this case is 1% × (365/30) =12.16%.

"Mutual Fund investments are subject to market risk kindly read all scheme related documents carefully"

Collateralized Borrowing and Lending Obligation - CBLO

*Collateralized Borrowing and Lending Obligation - CBLO* 

The Collateralized Borrowing and Lending Obligation (CBLO) market is a money market segment operated by the Clearing Corporation of India Ltd (CCIL). In the CBLO market, financial entities can avail short term loans by providing prescribed securities as collateral. In terms of functioning and objectives, the CBLO market is almost similar to the call money market.

The uniqueness of CBLO is that lenders and borrowers use collateral for their activities. For example, borrowers of fund have to provide collateral in the form of government securities and lenders will get it while giving loans.  There is no such need of a collateral under the call money market.

*Participants in the CBLO market* 

Institutions participating in CBLO are entities who have either no access or restricted access to the inter -bank call money market. Still, institutions active in the call money market can participate in the CBLO market. Nationalized Banks, Private Banks, Foreign Banks, Co-operative Banks, Insurance Companies, Mutual Funds, Primary Dealers, Bank cum Primary Dealers, NBFC, Corporate, Provident/ Pension Funds etc., are eligible for CBLO membership. These institutions have to avail a CBLO membership to do activities in the market.

*Instrument under the CBLO market* 

Collateralized Borrowing and Lending Obligation (CBLO) is the instrument in the CBLO market. It is a discounted instrument available in electronic book entry form for the maturity period ranging from one day to one year.

The CCIL provides the Dealing System through Indian Financial Network (INFINET) and Negotiated Dealing System for participating in the market.

In the CBLO market, members can borrow or lend funds against the collateral of eligible securities. Eligible securities are Central Government securities including Treasury Bills, and such other securities as specified by the CCIL. Borrowers in CBLO have to deposit the required amount of eligible securities with the CCIL. For trading, the CCIL matches the borrowing and lending orders (order matching) submitted by the members. Borrowers have to pay interest to the lenders in accordance with the bid.

Certificate of Deposit -CD

*Certificate of Deposit -CD* 

A certificate of deposit (CD) is a short-term security with a fixed interest rate and maturity date issued by a bank that seeks to raise funds from the secondary money market. Certificates of deposit are a special form of term deposits, which are issued for a specific reference period, usually up to 12 months, for a certain amount and a certain interest rate, fixed or variable, traded in the secondary money market. Regardless of the duration of a CD, the issuing bank is bound to pay off the coupons to the holder.

Short-term CDs have no coupons, and the holder receives the principal and accrued interest at maturity. However, in the case of a long-term certificate of deposit, the coupons are paid at regular intervals like, for example, every six months. The trading price of a CD in the secondary market is determined by its yield to maturity.

Commercial Paper - CP

*Commercial Paper - CP* 

Commercial paper, also called CP, is a short-term debt instrument issued by companies to raise funds generally for a time period up to one year. It is an unsecured money market instrument issued in the form of a promissory note and was introduced in India for the first time in 1990.

Companies that enjoy high ratings from rating agencies often use CPs to diversify their sources of short-term borrowings. This gives investors an additional instrument. They are typically issued by large banks or corporations to cover short-term receivables and meet short-term financial obligations, such as funding for a new project.

CPs have a minimum maturity of seven days and a maximum of up to one year from the date of issue. However, the maturity date of the instrument should typically not go beyond the date up to which the credit rating of the issuer is valid. They can be issued in denominations of Rs 5 lakh or multiples thereof.

Since such instruments are not backed by collateral, only firms with high ratings from a recognised credit rating agency can sell such commercial papers at a reasonable price. CPs are usually sold at a discount to their face value, and carry higher interest rates than bonds.