Factors Involving in the Fluctuations in Derivatives Market

Introduction: Background of the Study and Problem Statement

Derivative is a financial instrument that came from something else such as the financial instrument or an index or measurement. The term can be applied in the value from a set of the investors’ beliefs and sentiments about fundamentals in a stock market trades (AMS, 2003). The derivatives in the market are subject for a change; therefore there are factors that involved in the fluctuations which is the main topic.

Research Objectives

The objectives of the research are composed of the two main compositions. The first objective is to identify the factors involved in the fluctuations in the market derivative. The second objective is based on the first objective which is to push the right strategy to place an advantage in the appearance of the fluctuations in the market.

Research Questions

There are research questions that serve as the engine of the study. All of the questions are related to the main topic of the research and it will help the research for its completion.

1. What are the market derivatives?

2. What are the inefficiencies in the market?

3. What are the current strategies that applied by the organizations to avoid the inefficiencies?

Literature Review

Derivatives can e affected by different risks that are associated with the movements such as the borrowing, inflation, economic performance. An exposure of the derivative in the hedging requirements is suggested that can lead to losses and limiting the genuine investment transactions. The efficiency of derivatives market depends on the development of a liquid and efficient market for underlying securities and also on the suitable and acceptable benchmarks. It is also affected or carries the risk on account of fluctuations in the foreign exchange rates (Santoshmatre, 2006). Investors can use their powerful tool as an advantage to thrive the products in the pursuance of the investment strategies (Green and Luytjes, 1996).

These inefficiencies can take many forms. Counter-party risk in the physical market which described as the producer who is keen to sell forward a certain quantity of its commodity may be unable to find a buyer with satisfactory credit standing. Under a centrally cleared exchange environment, this is not a problem if the producer sells a futures contract. Counter-party “inflexibility” which is the same producer – if he had not used the futures market – may have difficulty getting out of the delivery obligation if he decided he did not wish to deliver. He may not be able to persuade the buyer to cancel the contract on reasonable terms. In a liquid futures market, he can simply buy back the position at a “fair” market price. Complexity of trade execution is in some underlying markets are simply not capable of providing efficient execution. The most common example is index futures. In most markets, an investor who wishes to track a benchmark index may find it impossible to immediately buy or sell the full set of constituent index stocks in the right proportion. An index futures contract satisfies this requirement very well. Stifling trading rules where many markets have trading rules that limits investors’ ability to act. The most common example is a ban or restriction on short selling. A futures or an options contract can be used to take short positions when this is prohibited, or hard to do, in the main underlying market. Excessive taxes appeared if the underlying market is subject to taxation that increases the cost of trading, a derivatives market can provide some relief (see page 5, Transactions Taxes & Fees for an example). Barriers to trade happens if exchange controls or other trade barriers are erected – for example by a government wanting to protect its own commodity producers – a derivatives exchange within that “protected” territory can flourish where it might otherwise be traded (AMS, 2003).

Methodology

The applied methodology of the research is the comparative case study which is very effective to measure the factors involving in the fluctuations of the derivative markets. Through the past studies the requirements as much as the questions can be identified. The comparative case study method can provide the current study to fill the gaps in the literature. Furthermore, the case study method is applied to invite the researchers to answer the main topic.

Conclusion

Through the examination of the past literatures and case studies, there are attitudes in derivatives. The obstacles to achieve the success in a new derivatives market can be on the interests included. The existing competition makes an impact in the fluctuations. The warrants and other structured products, margin trading, and foreign competition are the other factors that can affect the fluctuations in the derivative of the market.

References:

AMS, 2003. Derivatives Market Development, Key Success Factors in Building a New Derivatives Market. Alberta Market Solutions Ltd. [Online] Available at: http://www.albertasolutions.com/dmd.pdf. [Accessed 02 Feb 2010].

Green, J., & Luytjes, J., 1996. Derivatives, Powerful Tools in a Skilled Crafteperson’s Hands. SMM Secondary Mortgages Market: A Freddie Mac Quarterly, Vol. 13, No. 4. [Online] Available at: http://www.freddiemac.com/finance/smm/dec96/pdfs/grn_luyt.pdf. [Accessed 02 Feb 2010].

Santoshmatre, K., 2006. Equity: Scheme-specific Risk Factors. [Online] Available at: http://sbimf.com/Home/Downloads/scheme-risk-factor.pdf. [Accessed 02 Feb 2010].