Question

What is the act of buying a commodity at a lower price and selling it at a higher price? a. Buying short b. Discounting c. Tariffing d. Arbitrage

Short answer

The correct answer is \(d. Arbitrage\), which is the act of buying a commodity at a lower price and selling it at a higher price in another market to profit from the price differences.

Step-by-step solution

Understanding the terminologies

To solve this exercise, we should first understand the meaning of the given terms: a. Buying short: This is a term used in stock trading, referring to selling a stock that the seller does not own. The expectation is that the stock price will decrease, allowing the seller to buy it later for a cheaper price. b. Discounting: This is the process of reducing the price of a product or service, usually to encourage more purchases. c. Tariffing: This refers to imposing tariffs or taxes on imported or exported goods. d. Arbitrage: This is the simultaneous buying and selling of assets or commodities to profit from price differences in different markets. The main idea behind arbitrage is buying a commodity at a lower price and selling it at a higher price in another market.

Identifying the correct term

From the definitions provided in step 1, we can see that the term that describes the act of buying a commodity at a lower price and selling it at a higher price is "Arbitrage" (option d). So, the correct answer is: d. Arbitrage

Key concepts

Financial Markets

Financial markets play a crucial role in the global economy. They are the arenas in which people, corporations, and governments come together to exchange a variety of assets. These can include stocks, bonds, commodities, and various forms of money. The primary purpose of financial markets is to facilitate the raising of capital, transfer of risk, and international trade. They are broadly classified as capital markets, which include the stock and bond markets, and the money markets.

Within these markets, participants can engage in different types of trading activities to achieve their financial goals. For instance, investors may purchase stocks anticipating that the value will rise over time, providing them with a return on their investment. Markets also perform the important function of price discovery, where the laws of supply and demand determine the price of a traded asset. A deep understanding of financial markets can enable traders to spot opportunities for arbitrage – the practice of taking advantage of a price differential between two or more markets.

Stock Trading

Stock trading involves buying and selling shares of public companies with the aim of generating returns that outperform the broader market indices. Traders may adopt various strategies, such as day trading, where positions are held for just a few hours, or swing trading, where investments are held for longer periods to capture potential price movements.

The stock market is also a platform where the concepts of 'buying short' come into play. Short selling is a strategy where a trader sells stocks they borrow, hoping to repurchase them at a lower price. This strategy is speculative and can carry significant risk, as opposed to the standard practice of 'going long', where investors hold stocks expecting their value to increase over time. Understanding these mechanisms is essential, especially when examining various approaches to profit in the markets, including arbitrage strategies.

Price Differentials

Price differentials occur when there is a difference in price for the same asset or commodity across different markets or locations. Such discrepancies can arise because of variations in supply and demand, differing market conditions, or transaction costs among other factors. In an efficient market, these differences should be minimal as they will quickly be exploited by arbitrageurs.

In the context of arbitrage, traders seek to capitalize on price differentials by simultaneously buying an asset in one market where the price is low and selling it in another market where the price is high. Profit is made from the spread between the buying and selling price, and the strategy is considered relatively low risk if executed properly; since the buy and sell are contemporaneous, there theoretically should not be a risk of the asset losing value in the interim. However, successful arbitrage requires fast execution and access to multiple markets, making it a more viable tactic for sophisticated or institutional investors with advanced trading technologies.