Afaik, a true arbitrage profit opportunity must have 0 initial net cash outlay. According to my CFA materials, with a basis trade, say if the credit spread in the bond market is higher than the CDS spread, an arbitrageur would buy the bond and also the CDS protection. This hedges out the credit risk, but because there are initial payments required to be made to enter into these 2 positions, I’m confused at how this can be called an arbitrage trading strategy? Anything I’m missing here?
arbitrage = riskless profit opportunity. nothing more, nor less.
edit: i didnt read. my bad. to quote the definition in the book im using (McDonald). maybe it will help?
arbitrage: a transaction generating positive cashflow either today or in the future by simultaneously buying and selling related assets, with no net investment of funds, and with no risk.
Financial types have bastardized the word “arbitrage” to encompass low-risk transactions as well as no-risk transactions.
Thus, you hear of merger arbitrage or convertible arbitrage, neither of which are without risk.