One law of finance
|
Banking basics
A recap of a few things you’d think financial professionals ought to know
|
There is one thing to remember, at all times. A truth so eternal it should be on a pedestal, next to Newton’s laws of mechanics. Indeed it is a derivative of Newtonian mechanics: There is no perpetual motion machine:
If you stand to make money, you stand to lose money.
In a perfect world, with perfect information, equality of bargaining power, of rational market participants, in theory, equal, offsetting positions executed at the same time present no net risk, and so offer no net reward. This is the converse:
If you do not stand to lose any money, you cannot make any money.
Generally, indeed, the process of transacting involves incurring some expense: paying commissions, powering computers employing people whose opportunity cost is not doing something else — so putting on offsetting riskless transactions involves dissipating some energy from the immediate system, where it shows up in the wider system as unrecoverable heat: this is entropy.
Now it so happens that information is not perfect, markets are not rational and positions are not optimised. So it is possible, in separate transactions in disparate parts of the market to execute perfectly off-setting transactions that do result in a net gain. This is an arbitrage.