Arbitrage refers to riskless profits that are generated not because of a net investment but on account of exploiting the difference that exists in the price of identical financial instruments due to market imperfections. Eventually, these arbitrage opportunities are eliminated and supply becomes equal to demand.
Thus, the innate tendency for the price of a security to change is dispelled once the market is in equilibrium.
The aim of any investor is to maximize returns for a given level of risk or to minimize the risk for the given return.
Risks can be broadly classified as systematic or unsystematic.
Unsystematic risk is firm-specific and can be eliminated by holding
a diversified portfolio while systematic risk refers to market risk that can at best be mitigated by hedging. Hence, the market rewards an investor for undertaking systematic risk