Derivative trading makes it possible to transfer risk and to discover fair price by arbitrage mechanism. Consequently, it gives a much benefit to the market and economy growth. Specifically, the introduction of derivatives market and innovation of the products in the derivatives market becomes a standard instrument to risk management. By transferring risk from risk- averse investors to risk-love investors, market participants enable to expand their trading volume, and hence would contribute develop the financial system and the macro economy.
Also, derivatives trading may make a complete the capital market. If, in a market, there is an information asymmetry or market friction, then arbitrage strategies using derivatives give a much opportunity to get profit and hence discover the fair price of product. Therefore it helps to capture the information that is not easily available and hence converge to complete the financial market.
On the other hand, derivatives trading may result in negative consequences. Many finance researchers investigate the following topic: (1) Does futures and/...
Cheap and efficient trading is what securities traders wanted and that is what they got. Volumes transacted saw unprecedented increases, with the average daily number of trades going through the ceiling”(1.) This attests to the idea that with the advances made in technology today, Wall street will not be able to keep up. The “nerds” of society will be able front run the stock market and make more money in seconds than anyone could ever imagine.
In each case, regardless actual or simulated data, when the contract knocked out early, profit ended positive. While in scenarios where the accumulator continued through duration, profit was continually negative. Using actual data, a 4.5% knockout yielded a positive profit, however, a 10% knockout returned a large negative loss. Fok et al (2012) went further to enhance their study by comparing various knockout percentages (2-7%) and discount percentages (4-15%). They found that lower knockout percentages and higher discount percentages yielded the highest cumulative profits. Market trend severely affects knockout percentage, discount percentage and standard deviation showing that accumulators offer a reasonable investment for investors in a neutral or upward, yet when the market trend is downward, accumulator contracts become substantially more dangerous. Concluding findings show that accumulator contracts are an unfair investment due to their limited upside profit potential and unlimited downside loss potential (Fok et al,
The stock market is a centralized area where buyers and sellers comes together to perform stock transaction. When one thinks of the stock market, the first thing comes to mind is Wall Street which is sometimes referred to as the New York Stock Exchange as well as the NYSE.
Caterpillar Inc. also faces the risk of its cash flow and earnings being affected by fluctuations in the exchange rates of currency, commodity prices, and interest rates. To control for this, the company’s Risk Management Policy ensures prudent management of interest rates, commodity prices, and exchange rates of foreign currency by allowing the use of derivative financial instruments. According to the policy, the derivative financial instruments are not supposed to be used for the purpose of speculation. In its pricing strategy, Caterpillar Inc. faces the risk of difficult shipping of its products. This risk can be encountered by offering its products on instalments and lease to its loyal customers (Caterpillar, Inc. (CAT), 2011).
There are many different ways to save money and there are different things to save for. A savings plan for an immediate want is apparently different than a savings strategy for retirement. One may choose to select stocks, bonds, or mutual funds for a savings strategy, however, my personal choice is to invest in bonds first, then mutual funds.
Brokers who sold derivatives also actively bet against them at the same time they were telling customers that they were high-quality investments. Companies later made hundreds of millions of dollars while investors lost almost all of their
The expanding global market has created both staggering wealth for some and the promise of it for others. Business is more competitive than ever before, and every business, financial or product-based, regardless of size or international presence is obligated to operate as efficiently as possible. A major factor in that efficient operation is to take advantage of every opportunity to maximize profits. Many multinational organizations have used derivatives for years in financial risk management activities. These same actions that can protect multinational organizations against interest rate futures and currency fluctuations can be used to create profits for those same organizations.
In summary, investors on the whole are rational and contribute to an efficient market through prudent investment decisions. Each investor?s optimal portfolio will be different depending on the feasible set of portfolios available for investment as well as the indifference curve for that particular investor. Lastly, risk free borrowing and lending changes the efficient set and gives the investor more opportunities to either get a higher expected return with the same amount of risk or the same amount of return with less risk.
In conclusion, hedging risk with financial derivatives can give firm range of benefits such as lower probability of having financial distress, lower value of debt ratio, and earn tax benefit. It can be concluded that firm should hedge risk using financial derivatives because lot evidence shows that firm using this strategy is more successful than those who are not. However, since different type of companies facing different risks, they should not necessarily use the same hedging strategy.
Capital markets are markets "where people, companies, and governments with more funds than they need (because they save some of their income) transfer those funds to people, companies, or governments who have a shortage of funds (because they spend more than their income)" (Woepking, ¶3). The two major capital markets are stock and bond markets. Capital markets promote economic efficiency by moving funds from those who do not have an immediate need for it to those who do. Individuals or companies will put money at risk if the return on the intended investment is greater than the return of holding risk-free assets. An example of this would be those that invest in real estate or purchase stocks and bonds. Those that invest want the stock, bond, or real estate to grow in value or appreciate. An example of this concept would be if an individual or company invested an amount saved over the course of a year. While investing may be riskier, these individuals hope that the investment will yield a greater return than leaving the money in a savings account drawing nominal interest. In this example the companies that issue the stocks or bonds have spending needs that exceed their income so the company will finance their spending needs by issuing securities in the capital markets. This is a method of direct finance because the "companies borrowed directly by issuing securities to investors in the capital markets" (Woepking, ¶5).
If the development of Financial Market in America is like a sturdy adult, I would say the development of Financial Market in China is just like a child. The history of the U.S. financial market was established and has been growing over two centuries. For China, only twenty year has now passed since the financial market was built and growth. The Chinese financial market seems to be immature compared to the U.S. For example, China’s financial market does not have a thorough monitored stock market. The child is just starting to imitate the behavior and follow the step of the adult. However, the child is too young that mistakes always being made. On the other hand, since the child is in his early growth stage, a high level of growth is undertaking and a large progress might be attained. In today's China’s financial market, it is necessary for China to gather finance professionals in development of financial market. As a recent graduate student, working in the finance field less than a year, it is extremely hard for me in making a tiny positive effect on the growth of Chinese financial. However, to be engaged myself to the development of Chinese financial market is my long-term career goal.
...ting in hedging activities in the financial futures market companies are able to reduce the future risk of rising interest rates. By participating in the financial futures market companies are able to trade financial instruments now for a future date (Block & Hirt, 2005).
The stock market is an essential part of a free-market economy, such as America’s. This is because it provides companies the capital they need in exchange for giving away small parts of ownership in their company to investors. The stock market works by letting different companies sell stocks to gain capital, meaning they sell shares of their company through an exchange system in order to make more money. Stocks represent a small amount of ownership in a company. The more stocks a person owns, the more ownership they have of that company. Stocks also represent shares in a company, which are equal parts in which the company’s capital is divided, entitling a shareholder to a portion of the company’s profits. Lastly, all of the buying and selling of stocks happens at an exchange. An exchange is a system or market in which stocks can be bought and sold within or between countries. All of these aspects together create the stock market.
There is one thing that differentiates the international business with the domestic business where it uses more than one currency in the commercial transaction. For example, if a company from British purchases some goods from a company from US, the international transaction will require for exchanging pounds and U.S. dollars which involve the foreign exchange market. In the foreign exchange market, any country that wish to do business with foreign country, the country need to convert their domestic currency into the foreign currency that they are wish to cooperate with through foreign exchange.
This paper will define and discuss five financial theories and how they impact business decisions made by financial managers. The theories will be the Modern Portfolio Theory, Tobin Separation Theorem, Equilibrium Theory, Arbitrage Pricing Theory (APT), and the Efficient Markets Hypothesis.