Arbitrage investments can be tricky, and you want to make sure that you do not make a costly mistake when you being your investment journey. Before you begin any kind of investments, it is important that you make sure that you are familiar with all of the risks and laws that are associated with a particular type of investment. Arbitrage investing can be tricky because of the laws that are surrounding the rebates that must be paid out on each investment. Here are some of the basics of what you need to know if order to get started with investing in the arbitrage field.
Arbitrage is when an investor purchases a tax exempt bond that they will then immediately sell or invest into a taxable bond in order to generate an additional profit. Arbitrage investing is often done by day traders or other stock market experts that have a strong understanding of how investing in bonds is done. They also have to pay close attention to the markets so that they can understand what areas or bonds are being sold for a lower value in certain markets and how they can reinvest or sell those same bonds for a higher price and make a profit off of them.
When you work in arbitrage, then you are also going to be working a lot with arbitrage rebates. The arbitrage rebates are a payment to the US Federal government that are enforced by the IRS. The rebates exist in order to prevent an investor from abusing arbitrage laws. Since many traders are purchasing tax exempt bonds and then rolling them into taxable bonds, the rebate that they pay to the US Federal government controls how the money from the tax exempt bonds are used and makes sure that tax laws are followed correctly.
The amount that will have to be paid back in the arbitrage rebate to the government is going to be the same or equal to any extra profit that was made off of a bond that you did not reinvest in the government approved methods (i.e. you did not reinvest it into another tax exempt bond.) The process of calculating the exact amount of arbitrage rebate can be complex. It involves looking at the total yield that an individual bond received, and then also at the total amount of earnings that were paid out on investments that were made with that particular bond. You also have to factor in when the bond was issued and when it matured. It can be a complex process, which is why many investors seek the assistance of Arbitrage Compliance Specialists. They are experts in calculation of arbitrage rebates and can make sure that you are paying out the correct amount of rebate to the government. Arbitrage rebate calculations are done and rebates paid out about every five years, but it is important that you maintain all of your documents of the bonds during that period of time in order to make sure that your calculations are correct.