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Derivates in Market Essay

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INTRODUCTION

“A derivative is like a razor, you can use it to shave and make yourself attractive for your girlfriend, you can slit your throat with it or you can use it to commit suicide.’(Anon.) This statement describes to us the problems, and on the other hand rewards, that the proper use of derivatives can bring. The derivatives market has developed responding to the uncertainty about prices, and therefore provided a means of separating out this price volatility. The tendency of the market to move up or down in what appears to be a random manner has brought about the need for financial products which will protect or hedge the investor against the ill effects of market volatility. Certain types of derivatives …show more content…

- Holder of a futures contract is locked in an effective selling price therefore if he sells the contract against their position and then sees the market go up rather than down, he cannot take advantage of that upswing.
- If an investor wishes to take advantage of favourable yields but is aware this may increase interest rate exposure, the financial futures markets will provide an opportunity to hedge against possible loss.
- Gearing effect of the margining system means investors can quickly loose 100% of their investment, which wouldn’t be likely if they invested directly in bonds and shares.
-Holder of the contract can enter an offsetting contract with the same delivery month as the original contract and by this close out their position.
- Purchaser is forced to go through with the futures contract even if this is detrimental to them as mentioned earlier potential loss is unlimited.
- Futures contracts can provide great gains or losses (symmetric risk )
- Clearing House system guarantees that all contracts will be fulfilled.
- Risk of default is very low and the absence of some risk along with the presence of low transaction costs, ensures that the secondary market is highly liquid (i.e. A contract can be opened in one countries exchange and closed in another such is the high quality of the futures market.)
- Offers a cash efficient means of taking position in a market as futures are traded on margin. This allows for a geared

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