Changing the Stock Index Futures Prices - Essay Example

Changing the stock index futures prices such that there is no profit from cash and carry arbitrage is ill -advised. Apart from that, there are no other factors that affect stock index futures prices. INTRODUCTION: Investors prefer to enter into transactions that generate profits. Cash and carry arbitrage transactions includes paying for a commodity in the cash market with borrowed money. Then, the buyer of the commodity sells the corresponding futures contract in order to make a profit. Arbitrage can be described as the simultaneous buying and selling in two separate financial markets with the intention of making profits brought about difference between the buying and the selling prices of same specific commodity transacted. And, the carry cost is the amount of interest expense paid by the investor to hold on to the commodity purchased in the futures market until the maturity of the futures contract. Many bold and daring investors would enter into an arbitrage transaction where they would invest in shares of stocks in a corporation with the hope that the company will merge or consolidate with another company in the same line of business (Bjrk 2004, 1). The following paragraphs will explain in detail how commodity futures work. BODY: Changing the stock index futures prices such that there is no profit from cash and carry arbitrage is ill -advised. Most investors would enter into a cash and carry arbitrage contract. Their main reason would be to invest in two securities that are differently priced in the market with respect to each other. Eventually, the prices of both commodities will correct itself by either increasing or decreasing per commodity. For, a correction of prices would cause a profit on one commodity and a loss on the other commodity. Equitably, both commodities will zero out thereby future losses can be avoided or diminished to a great extend. The arbitrage investors would generate large profits or losses if they put large sums of money in one or more commodity. The commodities include gold, silver, coffee, sugar, oil, U.S. dollar currency, European dollar currency, Japanese Yen, French Franc, and other currencies. Also, "For as long as national currencies are in operation, and are used in day-to-day foreign trade, the demand and supply for those currencies will be affected by the size of exports and imports in those currencies" (Scobie, Buckley, and Fox 1998, 8) Further, the arbitrage investor would profit from his investments if he invests in a security and in the futures contracts. The investor would then profit if the amount he put in the commodity plus the added cost of carrying is less than the futures prices. One definite advantage of the commodities futures market is that the investors can sell a commodity like the European dollar today and then buy the same commodity, European dollar, three days from today. This is not possible in the real world outside the commodities market. A person cannot sell a product that he or she does not own. For this would entail personnel turning over to the buyer the car, house, shirt, or computer game the moment when he or she pays for the items bought (Blake 2000, 231). In terms of oil, "The oil industry, more than other energy sectors, is global in its character and operations. The geographical concentration of reserves and the vital role of oil in modern society has made it the principal commodity in international trade (Haugland, Bergesen, and Roland 1998, 54) " Also, the current pricing of Eurodollar futures and US dollar Foreign Rate Agreements (FRA) high frequency data shows that arbitrage opportunities are linked to the presence of stale FRA quotes and the oscillatory behavior of FRA quotes. And, Inter -market information flows are found to be of much shorter duration than previously reported with the futures market playing the dominant role in the information transmission process in the shorter -dated maturities. Many companies invest in short term interest rate futures and forward rate agreements for hedging short term interest rate exposures. The December 2003 global notional principal outstanding on all interest rate futures contracts shows US$ 13.1 trillion and foreign rate agreements stood lower at at US$10.8 trillion (Poskitt, 2008, 1). Furthermore, Foreign Rate Agreements had been developed by commercial banks as an alternative tool to interest rate futures for managing interest rate risk. The are similar to interest rate futures in many ways except for one thing. Interest rate futures are traded through the futures markets whereas the foreign rate agreements are traded through the over the counter markets. The foreign rate agreements have standard maturities. The foreign rate agreements do not require margin payments. The also do no require mark to market settlement payments. The foreign rate agreements are influenced by the three month London inter -bank offered rate or simply LIBOR. This is the same standard rate pegged by the Eurodollar futures contracts. The LIBOR rate is the key to the success of the success of investments in the foreign rate agreements. For, the foreign rate agreements can use the LIBOR rates to hedge against the Eurodollar futures contracts (Poskitt, 2008, 1). Normally, the foreign rate agreements mature in three by six, nine by twelve and six by 12 preferences. However, the foreign rate agreements could encroach on swap market money market activities when they are pegged to last beyond two years. Thus, it is advisable not to this long term type of foreign rate agreement. Foreign rate agreements do qualify as money market instruments. This new type of money market instrument are traded by commercial banks. The banks act as brokers for the United States dollar foreign rate agreements. The banks are open twenty four hours a day to advertise the bids of the buyers and the offers of the sellers (Poskitt, 2008, 1). In addition, the foreign rate agreement bid and offer prices are then published in the international news network Reuters. the bids and the offers are used as a guideline for both the actual buyers and sellers of the foreign rate agreements to reach an amicable or equilibrium price among themselves. Normally, the two parties to the foreign rate agreements settle their contract over the phone secretly among themselves. The two parties to one foreign rate agreement are not bound to divulge to the public or the futures market or the foreign rate agreement market itself their agreed price under the law of confidentiality of information. The secrecy of the foreign rate agreement transactions that have transpired from reporting to the inter -bank foreign rate market has made it difficult to conclude that investments in the Eurodollar futures and the United States dollar foreign rate agreements market(Poskitt, 2008, 1). In additon, "An important issue for exchange rate modelling is the relative importance of real versus nominal shocks in accounting for movements in real and nominal exchange rates. Disequilibrium models of exchange rate determination assume that prices in goods markets adjust sluggishly to shocks and that variation in real and nominal exchange rates is due primarily to nominal shocks (e.g., shocks to the money supply)"(Fisher 1996). Plus, one solid proof of the viability and over -all success of the foreign rate agreements is the survey data compiled and distributed by the Bank of International Settlements. This financial institution reported that the average turnover in United States dollar foreign rate agreements for the month of April 2001 alone reached $39 billion. on the other side of the fence, the CME reports show that the average daily turnover in the Eurodollar futures was higher than the foreign rate agreements at $759.6 billion. This only shows that the Eurodollar is the more popular money market instrument to invest one's hard earned money than the newly established foreign rate agreements. Many investors put their money in futures with end in mind of making profits (Poskitt, 2008, 1). Also, profits in the futures markets are gained when an investor puts his money in futures or foreign rate agreements by bidding and winning their bids. Then, these winning bidders will sell their newly acquired money market instruments to the highest bidder who will accept their offer price. Naturally, a higher difference between the price that the money market instrument is bought and the price at which the same items are sold would give higher profit. (Peel, and Taylor 2002). And, changing the commodity futures index futures prices such that there is no profit from cash and carry arbitrage would make hedging a useless undertaking. Hedging can be described as an investment that is taken out to reduce the future possible loss from another investment or undertaking. It is a strategy designed to reduce exposure to a feared future business risk while permitting the same business venture to profit from its normal business activity. A hedger usually invests in a security that seems to be under -priced in relation to the fair market value of another assets. For, example the value of a mortgage loan that investor had already entered into with another person or company. In financial circles, another example of hedging is when an investor indulges in short selling. short selling is defined as the situation where the seller of the commodity does not own the stocks he or she sells . Further, some investors enter into arbitrage to gamble. People would prefer to put their money in a certain activities with the hope of generating profits. This is the reason why there gambling joints are very popular. Some people invests in the commodities futures and the stock market with the hope of earning profits because they project that the prices of stocks and commodities will increase in the near future. The removal of the profit function of the commodities market would surely drive away the profit hungry individuals and corporations from investing in the United States dollar, the European Union dollar, the sugar commodity, the gold commodity, the oil commodity, the coffee commodity(Maizels, Bacon, and Mavrotas 1997, 85). And, some people would invest in the commodities market to effect actual delivery of gold, oil, United States dollar, European dollar, Coffee. Yes, the investors could take advantage of the commodities market because they only have to pay a small percentage of the entire price of the price of coffee. The investor will just have to pay the remaining balance of the commodity price to effect thy physical delivery of the coffee and other items ordered through the commodities market. In layman's term, the futures market can be described as a businessman who enters into an agreement with the orchard owner. The agreement would state that orchard owner will sell the entire apple fruit harvest six months from today solely to the businessman. The businessman gets the nod of the orchard owner that only a small percentage of the total estimated future fruit harvest will be paid as down payment. Thus, the businessman prepares his grocery for the arrival of the apples six months before the actual harvest time. The businessman will benefit from the hedging here because he knows that the apples will cost higher if he will only buy the apples during harvest time. On the side of the orchard owner, he benefits from the hedge because he knows there is a ready market for his apples when harvest time comes six months in the near future. The orchard owner will benefit because he can plant other trees in his orchard because he knows that a strong demand for his apples would generate more hedge sales from the additional new apple tress planted. Apart from that, there are no other factors that affect stock index futures prices. Maslow stated that man's three basic needs are food, clothing and shelter. Man needs to eat three full meals a day to survive. Man must prioritise filling his empty stomach with energy giving carbohydrates, vegetables, essential minerals and vitamins so he or she can work well in the office, study well his or her class lessons or stroll around the part. A human being also needs a shirt to protect his or her body from the freezing snow outside during the winter months. A person also needs the clothes to protect himself or herself from skin cancer -causing hot rays of the sun during the summer months. Man also needs clothes to protect himself from the insect bites, dog bites, snake bites and other dangers while he or she is walking in public places(Combs 1999, 1). Further, a person needs a house to keep him or her safe from the dangers of hurricanes, scorching heat of the sun, and other natural health -damaging factors. man can then only move on to fill his or other higher needs after filling these three basic human needs. The other needs include the self -actualization needs that include acceptance by another person as a friend. Another such need is buying a yacht. Another higher heed is for one to be loved. In short, "There are at least five sets of goals which we may call basic needs. These are briefly physiological, safety, love, esteem, and self-actualization. In addition, we are motivated by the desire to achieve or maintain the various conditions upon which these basic satisfactions rest and by certain more intellectual desires" (Maslow 2000, 3). In addition, another higher need is for the person to win tournaments or prices. He or she would love to play basketball or see a soccer game Winchester. The Maslow needs are a strong basis for man to delve or not in the commodities market. A man with lots of idle cash would be happy to invest in the United States dollar because he believes that the currently devalued United States dollar will bounce back in the near future. On the other hand, a person earning a minimum wage would not care about the increase or decrease in the commodity price of the European dollar. All he thinks of is how where to buy the next breakfast or lunch. Maslow theorised that " developing his hierarchy of needs, maintained that after survival and security, affiliation is the first psychological need of the human being, and which Miller (1976) defined as the need for community as expressed in connectedness, relatedness, interdependence, and belonging.(Coy, and Kovacs-Long 2005)" In terms of economics, the commodity prices are influenced by the news of the economic well being of a nation. Many European companies would not find as profitable to sell their goods to the United States market because the United States currency has decreased compared with the Asian currencies and the European dollar. Thus, the profits of European businesses have been cut by the decline in the value of the American currency. This factor alone triggers many investors not to invest in the American currency. On the other hand, Many investors would be enticed to invest in the United States currency in the futures market if economic news filters to the investors stating that the United States economy is slowly moving fast will soon bounce back to its former economic profitability(Lai, and Yu 2003, 53). In terms of the United Kingdom economy, "The economy recorded strong growth in the second half of last year, expanding by 0.8 and 0.9 per cent in the third and fourth quarters, supported by the strength of domestic demand. Preliminary estimates show an expansion of GDP of 0.6 per cent in the first quarter."(Kirby, Metz, Riley, and Weale 2004) Also, another important factor that affect stock index futures prices is the supply and the demand theory applied to the commodities offered in the futures market. The demand theory states that the number of units sold in the commodities futures market will increase if the price of the commodity decreases. In reverse, the number of commodity units sold in the commodities market will decrease if the selling price of the commodity will increase. In terms of the supply theory, the suppliers ( the commodity sellers in the commodity futures market) will increase the number of units they will sell if the price of the commodity increases (Ross 2004, 49). Further, "normal market conditions falling prices would be expected to result, at least in the medium term, in a decline in output, and not an increase. This points to the influence of one or more new elements in the commodity markets which were not operative before the mid-1980s, and which resulted in expansion in the volume of commodity exports from a wide range of developing countries (Maizels, Bacon, and Mavrotas 1997, 10) " In the United Kingdom housing sector "But under competitive market conditions, the lot of disadvantaged people is aggravated by such factors as heat poverty (poor insulation leading to excessive fuel bills, high cost or dangerous forms of heating, cooking and lighting, need for supplementary heating or cooling), unsafe dwellings.(Clark 2001)".This only shows that housing prices are based of the capacity of the buyer to pay. CONCLUSION: Investors would prefer to enter into transactions that generate profits. Cash and carry arbitrage transactions includes paying for a commodity with borrowed money. Then, the buyer of the commodity sells the corresponding futures contract in order to make a profit. The changing stock index futures prices such that there is no profit from cash and carry arbitrage is ill advised. an investor would not buy a commodity if he or she will not profit from the price fluctuations. Also, the current pricing of Eurodollar futures and US dollar Foreign Rate Agreements (FRA) high frequency data indicates that arbitrage opportunities are linked to the presence of stale FRA quotes and the oscillatory behavior of FRA quotes. And, inter -market information indicate that there is a strong demand for investments in the foreign rate agreements especially in the U.S. currency and the European dollar. Many companies invest in short term interest rate futures and forward rate agreements for hedging short term interest rate exposures. Apart from that, there are no other factors that affect stock index futures prices. These factors include the supply and demand theory. 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