What is the concept of 'arbitrage'?

Arbitrage is fundamentally the practice of buying and selling the same asset across different markets to exploit price differences, allowing traders to make a profit without taking on any significant risk. This process occurs because the same asset can be valued differently in separate markets due to various factors, such as timing, market inefficiencies, or differing supply and demand dynamics.

By engaging in arbitrage, traders can take advantage of these disparities. For example, if a stock is priced lower on one exchange than it is on another, a trader can purchase the stock on the lower-priced exchange and simultaneously sell it on the higher-priced exchange. This trade captures the difference in prices, yielding a profit.

The other options present concepts that diverge from the core idea of arbitrage. Creating new financial instruments pertains to innovation in finance rather than exploiting existing market inefficiencies. Investing in long-term securities focuses on a strategy aimed at building wealth over time, rather than capitalizing on short-term price discrepancies, which are the crux of arbitrage. Lastly, risk diversification strategies involve spreading investments across various assets to mitigate risk, contrasting with the low-risk nature of arbitrage that targets specific price mismatches.