>> Thursday, February 27, 2014
Unless you are deep in your financial cups, you should probably leave something as ridiculous as arbitrage calculation to someone who knows what he or she is dong. If you are like most people, you do not even know what arbitrage is, and there is no real way to work it out by looking at the word and breaking it into its pieces. As you will notice one of those pieces is “rage,” so if you guess someone who gnashed with anger, you could be forgiven but would still be incorrect.
Greater and Lesser Interest
The easiest way to understand arbitrage is that it is the greater interest made on a lesser interest tax exempt loan. While the following example isn’t necessarily correct, it will make the information available to the common person. You get a school loan with a 6% interest rate, but rather than paying for school with the loan, you put the money into an investment that yields 10%. When the time comes, you pay off the loan and pocket 4% difference. That 4% would be subject to arbitrage taxes.
What Is Subject to Arbitrage?
Most people will not encounter the rules for arbitrage because they do not deal in things like municipal bonds. Generally, the debt issued by the government to build things is subject to arbitrage depending on how the proceeds are stored. Arbitrage came about because the government doesn’t want businesses or people to get the money, put it in a high yield investment, and profit from it. If arbitrage did not exist, debt might be issued sooner and remain out longer.
Pluses and Minuses
The reason that arbitrage calculation is so hard is that most investments do not just go up. Typically speaking, an investment will fluctuate with the market. The first six months it might fluctuate between a positive 10 and 12%, and the next three months it falls to -3%. Getting a tax specialist involved who knows the rules of arbitrage and how to mitigate the financial losses will help any company that has government money long enough to want to invest it to stave off inflation concerns.