Guaranteed arbitrage opportunities

Arbitrage opportunities worth taking are rare. Most arbitrage opportunties involve risk. A common arbitrage involves borrowing at lower short term rates and investing at higher long term rates while pocketing the spread. The risk is that short term loan rates rise higher than your long term investment rates and your borrowing costs exceed your investment income.

Another common arbitrage is to take advantage of fixed for life low rate balance transfer checks and invest the money at a higher rate. This often can cause cash flow problems due to the minimum monthly payment due on your credit card. There is excellent discussion about this particular take on this idea here - investing w/ credit line promo rates: strategies, FAQ , links, Ld1cf8f05d8be38e57bac691cd7a253da info, etc. RE making $$$ from credit . Once in a while you can find a guaranteed arbitrage where your borrowing costs are fixed below your investment return and you can manage the cash flow. Please post any other guaranteed arbitrage deals here.


Below are examples used in the original op.
Example #1
Take a Pen Fed 5/1 ARM at 4.250 with .375 in points paying $2,544 in closing costs ($750 in deductible points) Interest after 5 years is $40,648.

Invest $200,000 in Pen Fed 5.00 apy 5 year cd's and have $255,256 at the end of 5 years

55,256 in interest income
-40,648 in mortgage interest
- 2,544 in closing costs
_______
$12,604 profit

Issues, allocating certificates for deposit insurance (if similar to FDIC insurance), CASH FLOW, being able to close before cd rates go down.)

Example #2

Citibank Heloc 6 month intro 1.99% variable interest rate.

200,000 1.99v Heloc over six months =$1,979 in interest
200,000 ED savings account 3.25 rate for 6 months =$3,272 in interest.

3,272 interest income
-1,979 mortgage interest
______
$1,293 profit

Issues, no closing cost loan, but must refund Citibank their closing expenses if line is closed within 3 years, ED savings account rate may not rise as fast as the equity line rate(if it rises above your savings rate you can always just pay off the line with your savings account)

Example #3(expired Heloc now 1.99%)
Kinecta Federal Credit Union 0% 4 month fixed intro Heloc

200,000 heloc fixed for at 0 for 4 months
200,000 in Ed savings account at 3.25 = $2,175 in interest income

$2,175 interest income
- 150 2nd, and 3rd year fees
________

$2,025 profit

Issues, no closing cost loan, but must pay Kinecta $500 in closing costs if closed within one year, not available in every state, must satisfy membership criterion, $75 in annual fees if you don't have an average daily balance of $10,000.

slimcustomer said:

Example #1
Take a Pen Fed 5/1 ARM at 4.250 with .375 in points paying $2,544 in closing costs ($750 in deductible points) Interest after 5 years is $40,648.

Invest $200,000 in Pen Fed 5.00 apy 5 year cd's and have $255,256 at the end of 5 years

55,256 in interest income
-40,648 in mortgage interest
- 2,544 in closing costs
_______
$12,604 profit

.

You forget about tax. After paying tax on your interest income, you lose money.

And it takes too much work to make that money. You also take a hit on your credit record.

It is easier to just take advantage of arb opportunities in the stock or bond markets. Of course, you need tons of cash and a lot of experience to begin with. . . .

OP deserves more credit here.

First, OP starts by granting that "Arbitrage opportunities worth taking are rare.", and isn't saying any of these deals should necessarily be done--just that they are potentially interesting.

Second, tax issues RE mortgage debt also depend on whether you take the std deduction or itemize AND whether you record the interest as investment debt rather than home purchase debt (which it would legitimately be in the OP's hypotheticals.)

Third, there is another advantage to these type of opportunities that OP doesn't mention: they can serve as an emergency reserve fund. So, if I have a $200,000 mortgage and $200,000 in CDs, I have a huge emergency cushion in the form of the CDs, which are breakable. (Note that the same reserve-fund role can often be served by a HELOC.)

(Edit for typos)

nothin better than sticking a few hundred K in a bank account. Helps in all kinds of other financial deals. Lenders, businesses, etc LOVE to see you have substantial liquid assets.

kharvel said: And it takes too much work to make that money.It takes a lot of work just to breathe. If you're willing to breathe, why aren't you willing to profit?

What about arbitrage situations where you discover that an insurance company is way off in their projections on something like the life expectancy of inner city youth? Are there any great illiquid markets left? I remember seeing companies listed on the OTCBB with market caps of $500. It certainly seems like you could buy all the shares then set your ask price several times higher although I don't know if that would count as arbitrage. Another possible opportunity is the 6.25% rate mentioned here recently for overpaying certain taxes.

You can avoid the taxes by simply setting up a LLC to do all this for you. The interest is counted as an expense, the interest income is counted as income....so you only pay taxes on the actual "profit." - So, no tax issues!!!

Now, someone else said this may look good on your financials when going in for a loan or something.
That's what I was thinking. What if I do take the $200k loan but then also have $200k in the CD....it seems to balance out the assets/liabilities, but I suppose the difference is that the 200k loan is amortized over several years whereas the $200k CD is available whenever you want. You might have to forgo the interest and may have a slight penalty...but still having that much liquid cash is beautiful for any lender to see!...do you guys agree? or is having too much debt make it even worse?

Well, in that case, since lenders love to see cash even when there is an equal amount of loans (actually more considering big house loan)...then how can I get qualified for such a nice big $200k loan so easily so that I can take advantage of this arbitrage opportunity....while at the same time preparing myself to look good for the lenders because I will have so much liquid cash.

Thanks slim! I like seeing what the latest "best deals" look like and old posts are hard to find when I look at new topics first.

I see the original post as an open call to beat the 3 deals presented.

Nice contribution, OP. Now will someone post links, or will I have to find them

1. The standardized vs. itemization equation is really a bit complicate. Let's say the thresshold is $9800 (what you get for forgoing the itemization). First, factor in your "sunk costs"-- the costs you MUST pay year after year. Generally, this will be your state taxes and your property taxes, and for many a base charity amount. Your HELOC arbitrage comes into play AFTER these. IF you will deduct $13800, but your "sunk costs" are only $7800, then you would be getting no effective tax break on the first $2000 of the $6000 itemized costs after the "sunk costs".

2. Personally, in this era of "sue the person you rear-ended" and insane costs for emergency medical proceedures, I'm a little leary of having extra cash sitting around, as it may attract attention and be fair-game in a lawsuit. Especially in a state such as Texas, where it's hard to go after house liquidity, but all other assets are fair game. So there is some risk in these strategies, although you've eliminated risk involving interest rate differentials.

Have someone overseas and wire transfer all cash to him when you do rear-end"

teammjs said: Nice contribution, OP. Now will someone post links, or will I have to find them

1. The standardized vs. itemization equation is really a bit complicate. Let's say the thresshold is $9800 (what you get for forgoing the itemization). First, factor in your "sunk costs"-- the costs you MUST pay year after year. Generally, this will be your state taxes and your property taxes, and for many a base charity amount. Your HELOC arbitrage comes into play AFTER these. IF you will deduct $13800, but your "sunk costs" are only $7800, then you would be getting no effective tax break on the first $2000 of the $6000 itemized costs after the "sunk costs".

2. Personally, in this era of "sue the person you rear-ended" and insane costs for emergency medical proceedures, I'm a little leary of having extra cash sitting around, as it may attract attention and be fair-game in a lawsuit. Especially in a state such as Texas, where it's hard to go after house liquidity, but all other assets are fair game. So there is some risk in these strategies, although you've eliminated risk involving interest rate differentials.

Getting off-topic but I don't think that arbitrage has to be risk-free (although the intent of arbitrage is to make a minimal risk profitable transaction) but I would agree that what the OP is describing has nothing to do with arbitrage. Borrowing money at one rate and investing it at a higher rate while smart is not arbitrage by any definition that I am aware of or could find online.

Examples:


Link1
Link2
Link3

slimcustomer said: As per Wikipedia
_________________________________________________________
In economics, arbitrage is the practice of taking advantage of a state of imbalance between two (or possibly more) markets: a combination of matching deals are struck that exploit the imbalance, the profit being the difference between the market prices. A person who engages in arbitrage is called an arbitrageur.

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I'm not sure what the point of including that definition but it does not support your position that this is arbitrage. There is no imbalance here. You are not exploiting inefficiencies or imbalances in the market. Credit card companies are willing to loan money at 0% for a period of time as a marketing gimic to lure you in as a customer. They know full well that the $10k they are lending you at 0% could be invested elsewhere to make them money - they are making the conscious decision to take the upfront loss on the 0% rate with the hopes that you will continue to pay much more in interest later on.

If you opened a checking account that offered a free iPod and then turned around and sold that iPod on eBay would you consider that arbitrage as well? Really this is common sense, its a good deal but it is NOT arbitrage.

Thanks for your comments Winter. Please read the section on Rational Pricing on Wikipedia. This bit from Wikipedia in particular...

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An asset with a known price in the future, must today trade at that price discounted at the risk free rate. (Note that this condition can be viewed as an application of the above, where the two assets in question are the asset to be delivered and the risk free asset.) (a) where the discounted future price is higher than today's price: The arbitrageur agrees to deliver the asset on the future date (i.e. sells forward) and simultaneously buys it today with borrowed money. On the delivery date, the arbitrageur hands over the underlying, and receives the agreed price. He then repays the lender the borrowed amount plus interest. The difference between the agreed price and the amount owed is the arbitrage profit
_________________________________________________

I'm afraid if I start posting more complex definitions, I may lose some people on a thread which is really intended for fairly easy, uncomplicated arbitrage oppurtunities.

If you need further clarification, you could contact my commodities law professor and he could help you, but he would probably want you to take his course, in which case you could have just skipped reading the preceding paragraph.

I do think the title of this post needs work and should be changed from "Guaranteed arbitrage opportunities" to "low risk arbitrage opportunities".

I've always wondered who is worse off, the person who "fails to grasp" something (ie. can't understand, doesn't get the point, etc.) or the person that argues with that person. I think I am finished being the latter. 'nuff said.

Edited for update: Today's WSJ 9/9 discusses this exact same strategy(borrowing at a lower rate and investing at a higher rate) used by municipalities. It goes into detail, describing the strategy as arbitrage. It's good to know that at least the WSJ agrees with me .

way to go guys. crapping up an otherwise interesting thread.

From combining a 0% BT deal and emigrant, I think this is a nice 2nd step for beating the system. I would do example #2, if I didn't already have plans for my home equity...

OP - like the thread!

To me the biggest problem with the penfed example - and to a lesser degree with the others - is the time between the loan and the investment. If I were to start now to get the 4.25 - I would get the money in 30-60 days, and by then who knows what the CD rates would be. Given the general sense that rates are rising one would think this would be safe, but over a year ago I was buying 5yrcds at penfed for 5.25...

The 0% and no cost HELOC are simpler deals but they too have tradeoffs - as you mentioned in your post.

I would guess that all 3 examples would work out but there's enough risk to give me pause. I find the 0% CC floating to be less risky.

OP's calculation is also flawed. The actual calculation should assume the money is invested in a high yield savings account which monthly payment is withdrew from the savings account to fund the loan. So the final interest income should be much less than a CD.

Without this factor, OP's problem is simply a situation of paying cash vs loan.

In the penfed example I think fboyfboy is right that the calculation should show an allocation for payments - perhaps something like 200K-5 years payments at 5% and the remainder at something like ED rate.

Not real sure why so much focus on the tax issue, our tax situation varies and is a individual factor. I'm in the situation where the interest is deductible and the earnings are taxable - pretty much a wash taxwise.

Pretty sure that fboyfboy is wrong about Cd interest though - penfed pays monthly and it is taxable as you go - that interest could be used to pay part of the loan. And I'm not sure if the OP's calculations considered how that interest money would play into the earnings side?

With the recent volatility in interest rates, the possiblity for arbitrage opportunities grows. While mortgage markets can change daily, cd rates at credit unions are often adjusted as infrequently as once every quarter.