What is the difference between arbitrage mutual funds and liquid mutual funds?

If you want to park your idle funds for a short duration and would also like to earn some return, mutual funds offer some good options. Two such instruments are liquid and arbitrage funds. Though both serve the same purpose and offer similar risk and returns, these differ in several ways and cater to different categories of investors.

What are liquid funds?

These are short duration debt funds that invest in debt and money market instruments, such as commercial papers, government securities like treasury bills, and certificates of deposit, all with maturity periods of 91 days or less. These have no lock-in periods or exit loads. These also have the highest liquidity among all mutual funds as these can be redeemed within one business day.

How are these different?

What are arbitrage funds?

Arbitrage funds are hybrid funds that invest at least 65% of the corpus in equity and equity-related instruments. As the name suggests, these funds use the arbitrage strategy. They make the most of the price difference in cash and futures markets to buy and sell simultaneously. For instance, if an asset is priced at Rs.100 in one market segment, and at Rs.110 in another market, the fund buys from the former and sells in the latter, earning a profit of Rs.10. Despite being classified as equity funds, they are extremely safe because they are fully hedged.