Future Rates: a Means of Dealing for the Future - Essay Example

Future Rates: A Means of Dealing for the Future Future Rates: A Means of Dealing for the Future Introduction Future contracts are forged in order to hedge against the unfavorable market conditions that might arise in the time which is yet to come. The future contracting involves a deal that is planned to happen in the future (Pilbeam, 2013). The agricultural products and crops are usually sold pre-determinedly in order to minimize future market risk of falling prices. The producers enter into future contracting so that they can control risks of unfavorable price fluctuations (Copeland, 2008) whereas, industrialists who are responsible for transforming raw materials into finished goods take the option of futures in order to sustain supply for the days to come. The production cycle will remain running smoothly without experiencing any interruptions. The trend of futuristic deals is more prevalent and traditional in the market that works to sell and purchase financial instruments. The future contracts are more formal in nature and it is often considered unacceptable, if a party wants to break the contract or simply opt not to perform its contractual duties. The disadvantaged party reserves the right to take the matter into a court of law in response to the breach of a future contract (Moosa & Bhatti, 2009). The shares and bonds are purchased with the help of future contracts because it allows the purchaser to hedge against the possibility of higher price of the same instrument at a future date. The seller on the other hand tends to manage the risk of falling prices in the future by securing a deal in the present on a reasonable return rather than waiting for the actual market situation to emerge in the future (Pilbeam, 2010). Another interesting fact should be kept in mind that senior and experienced investors and businessmen do not enter into future contracts due to their formal nature but they tend to use options instead. The options are favored because of their informal nature and they can also be broken by paying modest mutually settled fees. In the case of future contracts, the ramifications of nonperformance are more severe in nature due to strict legality of the contract. Additionally, future contracts are entered by those investors and businessmen who do not want to take the pressure of facing market risks at a specific period of time and therefore, look and plan to safeguard their interests beforehand (Baillie & McMahon, 1989). The investors of abovementioned mindset safeguard their stance against rising prices but they also forego potential benefit that they may reap if the price of the instrument drops in comparison to the already negotiated cost. Futures are also used by desperate people who look for covering their immediate expenses that have been known to arise at some futuristic date. These kinds of people ought to ensure earning of needed funds and they do not care about probability of capital loss because of their urgent financial needs. The purchasers do not prefer future contracts but they usually forge them on humanistic basis as they tend to help those who are in need of quick buck. The futures are not a usual way of buying and selling shares in the international market and options along with on the spot dealings are more preferable in the eyes of investors in all parts of the world. The future prices upon which the instruments are sold at a present date are not absolute prediction of spot rates of the future. They are usually based on probability analysis and speculations (Sarno & Taylor, 2002). The spot rates are greatly influenced by political climate of the world and any good news can take rates to a higher level but a bad one can cause the stock markets to crash in the matter of hours. Future rates are getting more and more unreliable with the passage of time and the rise in uncertainty is caused by rising prices of oil, terrorism and inflation. The shortage of oil supply can alone send instruments of a particular company to experience an irrecoverable drop. The future rates are expected to drop as instruments’ values have been known to decrease over the passage of past few years. The sellers manage to attain capital gain as future rates are usually higher than those which prevail in the market at the actual time of exchange but the purchasers regret to enter into a future contract. In the light of above argument, sellers favor futures but buyers go for options and at the spot dealing and as sellers are at a strategically weaker position then they have to succumb to the demands of buyers. In the current market conditions, people at both ends of the deal follow the rule of wait and see and they delay their decision making to the last possible moment (Meese & Rogofp, 1988). The batters in baseball are guided to wait for the ball by their coaches. The players are told to have patience because if they tend to attack the ball then they will most probably imbalance themselves in the process playing the shot by losing their stand. The strength of stand is very important in terms of playing a strong shot and same is the case with investment decisions and therefore, one should wait for the actual time of investment and take the best option with respect to rate of return rather than hurrying into the decision. The philosophy of Kung-Fu states that one should patiently learn to walk slowly because in this fashion, he or she can see the path very clearly. The hurried individuals often regret to take a particular decision in life. Most of the marriages, romantic relationships, investments and contracts do not work out because involved parties did not give them sufficient thinking before jumping or plunging into the commitment (Bruce & Angel, 2011). The investment decisions are awfully similar to marriages because both of them are contracts in their fundamental natures and therefore, people should think hard before taking the final decision of entering any sort of commitment in personal and professional life. The humans are identified as impatient and they have to learn to control their impulsiveness in order to make sensible decisions both in their private and professional lives. Hypothesis Development The investors are strongly recommended to follow at the spot dealing as a preferable way of trading in instruments. The recommended technique helps them in managing risks of dropping prices and they do not have to go through significant level of psychological suffering which is accompanied with waiting for the actual time of exchange to come. The sellers have stronger bargaining strength than sellers and that is why, they are suggested to use their strength in order to gain monetary advantage (Meese & Rogofp, 1988). The risk averse investors are in need to slow down their decision making process so that they can indeed see the path ahead. They have to learn to wait for the right moment to take investment decisions as baseball waits for the ball in order to put adequate power in each and every shot. The application of futures remain however ideal for those purchasers who require securities immediately in order to cover their risks in the future. In normal circumstances, futures are not recommended as a means of trading financial instruments. The sellers will make every attempt in their power to trap junior investors into thinking that futures offer great advantages for them in the future but it is not the case in current setting of the financial market. The instruments are dropping in prices as companies do not have sufficient liquidity to pay debt and dividends. The numbers of bankruptcies are growing across borders and liquidations are happening more frequently. All of the mentioned factors along with other macroeconomic variables are playing their due hand in terms of driving down average instrument prices in all financial markets of the world and therefore, investors should not consider future rates as an effective predictors of the spot rates because they are influenced by many different variables. Conclusion This paper reviewed and analyzed the trend of using future contracting in various types of businesses and found that the technique is used in agricultural products’ deals in which farmers and industrialists enter into a future contract so that they can hedge against risk of dropping prices in the days to come and to ensure constant and steady supply of raw material respectively. However, in the trade of financial instruments, the technique is ill-advised because financial instruments are experiencing dropping of prices and therefore, sellers will be unduly benefitted from the abovementioned trend as they will become capable of selling the offering at higher price than the prevalent one. Finally, the investors are suggested to act patiently while they engage in the trade of financial instruments. References Baillie, R. T., & McMahon, P. C. 1989. The Foreign Exchange Market : Theory and Econometric Evidence. Cambridge University Press, Cambridge. Bruce, T., & Angel, S. 2011. Fixed Income Securities 3rd ed. Wiley Finance, New Jersey. Copeland, L. S. 2008. Exchange Rates and International finance. Prentice Hall, Harlow. Meese, R., & Rogofp, K. 1988. Was It Real? The Exchange Rate-Interest Differential Relation over the Modern Floating-Rate Period. The Journal of Finance Vol 43 No.4, 933–948. Moosa, I. A., & Bhatti, R. H. 2009. The Theory and Empirics of Exchange Rates. World Scientific, New Jersey. Pilbeam, K. 2010. Finance & Financial Markets. Palgrave Macmillan, Basingstoke. Pilbeam, K. 2013. International Finance. Palgrave Macmillan, Basingstoke. Sarno, L., & Taylor, M. P. 2002. The Economics of Exchange Rates. Cambridge University Press, Cambridge. Read More