Speculation and Futures Markets Flashcards
What are the roles of the Futures market?
1) Price insurance
2) Price discovery
How does price discovery arise?
Efficient market collects, processes and disseminates the information brought by investors through their price bid. These give signals to producers/distributors.
What does it mean for a market to be ‘paper-based’ ?
Quick/instant response to price changes thus if price is a function of ACCURATE information, markets are efficient and resources are allocated efficiently.
What is the impact of accurate price discovery?
Futures and spot price move together meaning hedging role is carried out effectively
What is the price that is being discovered?
1) Current price
2) Expected spot price
What is price insurance?
As market is thick, means it is highly liquid so risk is spread widely across more people.
What happens when the risk premium is too large?
Hedgers do not want to take on the risk so price discovery is not well done as futures price is not a good predictor of spot price
What impact do speculators have on risk premia?
They reduce it but taking on risk in search of profit, this makes price discovery more accurate.
What is the adequacy index?
Measure of the level of speculation (whether it is excessive in a market)
