What does the term 'arbitrage' refer to in finance?

Arbitrage refers to the practice of taking advantage of price differences in different markets to make a profit. This concept is fundamental in finance and involves simultaneously buying and selling an asset in different markets to exploit discrepancies in prices. For example, if a stock is priced lower on one exchange than another, an investor can buy it at the lower price and sell it at the higher price, thereby securing a risk-free profit.

This practice helps to ensure that prices do not deviate significantly from their fair value across different markets, thus contributing to market efficiency. By engaging in arbitrage, investors help to align prices, which benefits the overall functioning of the financial markets.