Functions of derivatives market, Financial Management

Functions of Derivatives Market:

To reduce risk or eliminate risks some ways and methods are there. Risk in the capital market can be reduced by diversification or putting eggs in different basket in the words of James Tobin. However, by diversification we can reduce company specific risk or unsystematic risk. There is also risk to the business due to fire, accident, theft etc but these can be insured. But there is one risk - systematic risk or market risk which occurs due to macroeconomic fluctuations in the economy and cannot be diversified away. This is the risk which if cannot be handled properly will lead to huge losses. To reduce systematic risk derivatives products are invented in the market. These derivatives products perform certain important functions. They are:

Provide Hedging Facilities to the Economic Agent: The futures market provides hedging facilities to the economic agent. Hedging can be obtained by taking opposite position in the futures market. Thus, one can use futures market to reduce or eliminate price risk.

Price Discovery: This market performs a very important economic function of price discovery. Prices in a futures market reflect the perceptions of market players about future and take the prices of the underlying to the perceived level. The prices of futures contracts converged with prices of underlying asset on the expiration date. Thus, futures market help in price discovery of not only future but also current prices in the cash market.

Augment Volume of Cash Market: The underlying cash market volume will witness a higher trading volume in presence of an efficient futures market. The simple reason is participation by more market players who earlier due to lack of these risk management tools kept themselves out of market will now trade in the cash market and augment the trading volume.

Shift Speculating Trading to Futures Market: In the presence of futures market, speculation shift from cash market to futures market which is more controlled and properly regulated by concerned authority. In the absence of futures market, these rouge traders trade in the cash market and monitoring, margining and surveillance become extremely difficult in such an environment.

 

Posted Date: 9/10/2012 8:47:22 AM | Location : United States







Related Discussions:- Functions of derivatives market, Assignment Help, Ask Question on Functions of derivatives market, Get Answer, Expert's Help, Functions of derivatives market Discussions

Write discussion on Functions of derivatives market
Your posts are moderated
Related Questions
Q. Working capital mini Qs? During January 20X4, Gazza Ltd made credit sales of £30,000 that have a 25% mark up. It also purchased £20,000 of inventories on credit. Calculat

SAM Technology had AED 640,000,000 of retained earnings on December 31, 2012. The company paid common dividends of  AED 30,000,000 in 2012 and had retained earnings of  AED 500,000

Explain about the debt policy Designing debt policy the debt policy of a firm is significantly influenced by the cost consideration. In designing financing policy, that is, p

Cash flow statement: The cash flow statement summarises the flow of cash into and out of the business over a certain period of time. The cash flow statement measures the liq

Put option is the right of the investor which he may exercise on the date at the put price given in the indenture. Normally, put price is in par value. When yield rises

X company sells on terms of 2/10, net 40. Gross sales last year were $4.5 million and accounts receivable averaged $ 437,500. Half of X''s customers paid on day 10 and took discoun

2.5. Västerås Corporation plans to buy a truck for $40,000 and depreciate it fully over 5 years using straight-line method of depreciation. However, it plans to use it for 8 years

Why does most interbank currency trading worldwide involve the U.S. dollar? Answer:  Trading in currencies worldwide is in opposition to a common currency which has international

The UK Pension Fund System The UK Pension system is a three pillar pension system. A flat-rate first-tier pension is provided by the state and is known as the Basic State Pensi

State the Examples of tests of controls: Check bank reconciliation has been reconciled as approved by chief accountant. Observe buyer checking the goods received note a