Stock market futures

Stock Exchange, market for the sale and purchase of securities of corporations and municipalities and in some cases, of certificates representing commodities of trade.

Originally, stock exchanges were free to anyone who wished to buy or sell; it was probably with this function in view that some of the older exchanges, notably the Paris Bourse, were established in buildings erected at public expense. It was quickly discovered, however, that in order to enforce bargains some formal organization was necessary. Membership in stock exchanges therefore came to be limited on the general basis used by clubs or other associations. The stock exchange plays an important role in the capitalistic economy. The initial sales of corporate securities are made by investment bankers. Thereafter, stock exchanges provide markets for the securities, enabling the original investors to sell their securities as the need arises, and thus encouraging original investment.

II. THE LEADING STOCK EXCHANGES IN THE WORLD

The leading stock exchanges in the world are the New York Stock Exchange, the London Stock Exchange and the Tokyo Stock Exchange. A further important exchange of a much less regulated sort is the National Association of Securities Dealers Automated Quotation (NASDAQ) system. This is a computerized market linking dealers throughout the United States and, to some extent, Europe. NASDAQ is the second-largest and fastest growing US stock exchange, and facilitates the trading of over-the-counter (OTC) securities which tend to be issued by somewhat less established companies as well as the shares of large companies.

The example of NASDAQ illustrates a general trend towards increased competition and the use of computerized trading systems to replace the traditional stock exchange :floor: where dealers and brokers meet and trade in :open outcry:. The London Stock Exchange has been entirely computer-based since the reorganization or :Big Bang: in October 1986, with dealers able to see all prices on screen instantaneously. In contrast, the New York Stock Exchange retains its trading floor. There has also been increased competition for the traditional national exchanges from new computerized trading systems produced by commercial companies. With the arrival of high-speed computers and advances in information technology, the cost of providing a centralized market for shares via computer screens has reduced dramatically.

By using alternative trading systems it is sometimes possible to reduce transaction costs and also avoid some of the regulations that formal stock exchanges inevitably impose. Similarly, there is much competition between the stock exchanges of different countries. For example, it is possible to buy and sell French shares on the Londoncity market, using the Stock Exchange Automated Quotation International (SEAQ International) system. SEAQ International has been dramatically successful in capturing market share from the domestic stock exchanges of many countries, to the extent that, for some countries, a larger proportion of trades take place in London than on their own exchanges.

As competition between exchanges has developed, the trading systems of stock exchanges have divided into two broad categories. First, some leading exchanges:for example London use the market maker system. Under this system market makers continuously quote the prices at which they are prepared to buy and sell each share. Investors are able to see these prices, and the stock exchange rules specify that all trades should take place at the best prices for investors. All the prices are visible on computer screen, and market makers are committed to honouring their prices for trades up to a certain size. For trades above the Normal Market Size market makers\' prices are indicative only, and negotiation with the market makers will finalize the price. The perceived advantages of the system are immediate execution of orders, and price certainty at any point in time.

The second type of trading is the auction system, whereby all buy and sell orders from investors are collected together and matched against each other, with the price being set to attempt to clear the market. A leading example of auction-based systems is the Paris Bourse. Auctions can be continuous, usually operated by computer, or batch auctions, which occur once or twice a day. The advantage of such a system is cheapness, although it may not be possible to trade immediately or at a known price.

Stock exchanges around the globe are developing rapidly, and facing competition both from each other and from new high-tech entrants. It seems likely that there will be a continued trend towards concentration of share trading in a few leading centres, with domestic stock exchanges in some countries becoming increasingly irrelevant. Within Europe, for example, there have been moves to develop a pan-European stock exchange, although to some extent this already exists in the form of SEAQ International. Individual countries seem loath to give up their domestic stock exchanges, although as financial markets are now so liberalized, and as information technology develops further, there is nothing to stop individual investors using whichever stock exchange system is the cheapest or most efficient.

III. FEATURES OF FUTURES

Highly standardized : Futures are standardized and legally enforceable. Hence, they are traded only in organized future exchanges. It is also difficult to modify the agreement according to the needs of the contracting parties. However, many variants of futures are available. But, once the agreement is entered into the chances of modifying it are very remote.

Down payment : The contracting parties need not pay any down payment at the time of agreement. However, they deposit a certain percentage of the contract price with the exchange and it is called initial margin. This gives a guarantee that the contract will be honoured.

Settlements : Though future contracts can be held till maturity, they are not so in actual practice. Futures instruments are marked to the market and the exchange records profit and loss on them on daily basis. That is, once a futures contract is entered into, profits or losses to both the parties are calculated on a daily basis. The difference between the futures price and the spot price on that day constitutes either profit or loss depending upon the prevailing spot prices. The spot price is nothing but the market price prevailing then. Generally, these profits or losses are accumulated in the margin accounts of the arties. But, if there are continuous losses and if the initial margin falls below a minimum level called maintenance margin, then the exchange authorities will interfere. In such a situation the contract automatically lapses. The default risk due to such a lapse is limited to the profit or loss booked during that day. Since the exchange guarantees the performance of the contract by both the counterparts, the default risk is borne by the exchange.

Hedging of price risks : The main feature of a futures contract is to hedge against price fluctuations. The buyers of a futures contract hope to protect themselves from future spot price increases and the sellers from future spot price decreases. Parties enter into futures agreements on the basis of their expectations of the future price in the spot market for the assets in question.

Linearity : As stated earlier, futures contract is nothing but a standardized forward contract. Therefore, it also possesses the property of linearity. Parties to the contract get symmetrical gains or losses due to price fluctuation of the underlying asset on either direction.

Secondary market : Futures are dealt in organized exchanges and as such they have secondary market too.

Non-delivery of the asset : The delivery of the asset in question is not essential on the date of maturity of the contract in the case of a futures contract. Generally, parties simply exchange the difference between the future and spot prices on the date of maturity.

IV. TYPES OF FUTURES

Like forwards, futures may also be broadly divided into two types namely :

Commodity futures : A commodity future is a futures contract in commodities like agricultural products, metals and minerals. In organized commodity future markets, contracts are standardized with standard quantities. Of course, this standard varies from commodity to commodity. They also have fixed delivery dates in each month or a few months in a year. Some of the well established commodity exchanges are as follows:

a. London Metal Exchange to deal in gold.

b. Chicago Board of Trade to deal in soya bean oil.

c. New York Cotton Exchange to deal in cotton.

d. Commodity Exchange, New York to deal in agricultural products.

e. International petroleum exchange of London to deal in crude oil.

Financial futures : Financial futures refer to a futures contract in foreign exchange or financial instruments like Treasury bill, commercial paper, stock market index or interest rate. It is an area where financial service companies can play a very dynamic role. Financial futures are very popular in Western countries as hedging instruments to protect against exchange rate or interest rate fluctuations and for ensuring future interest rates on loans. Just like forward rate currency contracts and forward rate contracts on interest rates, we have futures contracts on currency and interest rates. But the primary objective of futures markets is to enable individuals and companies to hedge against price fluctuations. The stock futures contract is a futures contract on major stock market indices. This type of contract is very much useful for speculators, investors and especially portfolio managers. They can hedge against future decline or increase in prices of portfolios depending upon the situation. Generally, the asset will not be delivered on the maturity of the contract. The parties simply exchange the difference between the future and spot prices on the date of maturity. But these kinds of financial futures are relatively new. Some of the well financial futures exchanges are the following:

International Monetary Market to deal in U. S. treasury bills, Euro dollar deposits, Sterling etc.

London International Financial Futures Exchange to deal in Euro dollar deposits.

New York Futures Exchange to deal in , Euro dollar deposits etc.

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