Derivative Markets Essay Example | Topics and Well Written Essays - 1750 words

Derivative Markets - Essay Example There are several limitations in the price of future contracts and it is ensured by future arbitrage. The existence of price limits help to minimise the instability of prices by defending organizations against market overreaction. However, price limit can also make future contracts less liquid. Future arbitrage makes future contracts more valuable. Arbitrage generates a strong connection among the futures and commercial values (New York University, n.d.). Limit of arbitrage is significant for behavioural descriptions of irregularities and wider revision of asset valuation. Limit of future arbitrage is a portion of finance plan to clarify variances based on investors’ emotional prejudices. Arbitrageurs can face the following price limitations: Fundamental and non-fundamental risks Short-selling costs Leverage and margin constraints Constraints on equity capital Thus, the above statement 2 is true i.e. there are some defined limitations in future arbitrage in pricing future cont racts (Gromb & Vayanos, 2010). Statement 3 â€Å"A swap contract can create a win/win situation for two swap players plus the financial intermediary arranging the swap† The interest rate swap is a derivative to interchange interest rate for accomplishing lesser borrowing rates. Swap players can change interest rate from static to floating and vice versa. Swapping is beneficial when one player desires to get an amount with a floating interest rate while other player wishes for preventing future risks by getting a static interest rate in its place. In swapping, both players have their own primacies and desires, thus it (swapping) can create win/win situation for them... This essay states that in recent times, the world has converted into an uncertain place for financial organisations. Fluctuations in interest rates have extended, and stock markets are running through growing unpredictability. As a consequence of these variations, the financial organisations have happened to be more anxious about minimising the risks. As the demand for risk reduction techniques has enlarged, it has generated innovative financial tools named financial derivatives. These tools are very convenient in minimising the risks and help financial organisations to hedge. Hedging is a method which is used by financial organisations to counteract the regular risks of price variations. It is considered as important risk managing instrument for portfolio managers, bank executives and corporate accountants. In any derivative contract, the seller comes to an agreement to provide asset at a particular period in future and purchaser approves to pay fixed value for that asset. One can b uild a clean arbitrage if the future contract is mispriced. Majority of future contracts are priced according to arbitrage. In derivative contract, organisations need to choose investments which can provide good return with estimated price measures. It is also termed as speculation. Speculation is a procedure used in finance for securing profit from riskier investments, but it does not ensure security on investment or principal amount. Speculators use several approaches to make a decision prior to obtaining additional risks through investment.