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Financial markets

Bond market Fixed income Corporate bond Government bond Municipal bond Bond valuation High-yield debt Image File history File links Question_book-3. ... This article does not cite any references or sources. ... Download high resolution version (480x640, 110 KB)Blockade in front of NYSE. Picture taken in April 2004. ... The bond market, also known as the debit, credit, or fixed income market, is a financial market where participants buy and sell debt securities usually in the form of bonds. ... This article does not cite any references or sources. ... A corporate bond is a bond issued by a corporation. ... A government bond is a bond issued by a national government denominated in the countrys own currency. ... In the United States, a municipal bond or muni is a bond issued by a state, city or other local government, or their agencies. ... Bond valuation is the process of determining the fair price of a bond. ... In finance, a high yield bond (non-investment grade bond, speculative grade bond or junk bond) is a bond that is rated below investment grade at the time of purchase. ...

Stock market Stock Preferred stock Common stock Stock exchange A stock market is a market for the trading of company stock, and derivatives of same; both of these are securities listed on a stock exchange as well as those only traded privately. ... For other uses, see Stock (disambiguation). ... A preferred stock, also known as a preferred share or simply a preferred, is a share of stock carrying additional rights above and beyond those conferred by common stock. ... Common stock, also referred to as common shares, are, as the name implies, the most usual and commonly held form of stock in a corporation. ...

Foreign exchange market Retail forex The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. ... The Retail forex (Retail Currency Trading or Retail Forex or Retail FX) market is a subset of the larger Foreign exchange market. ...

Derivative market Credit derivative Hybrid security Options Futures Forwards Swaps A derivatives market is any market for a derivative security, that is a contract which specifies the right or obligation to receive or deliver future cash flows based on some future event such as the price of an independent security or the performance of an index. ... // A credit derivative is a financial instrument or derivative (finance) whose price and value derives from the creditworthiness of the obligations of a third party, which is isolated and traded. ... Definition A hybrid security, as the name implies, is a security that combines two or more different financial instruments. ... In finance options are types of derivative contracts, including call options and put options, where the future payoffs to the buyer and seller of the contract are determined by the price of another security, such as a common stock. ... In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. ... For the Thoroughbred horse racing champion, see: Swaps (horse). ...

Other Markets Commodity market OTC market Real estate market Spot market Chicago Board of Trade Futures market Commodity markets are markets where raw or primary products are exchanged. ... Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. ... Real estate is a legal term that encompasses land along with anything permanently affixed to the land, such as buildings. ... Template:The Spot Market The Spot Market or Cash Marketis a commodities or securities market in which goods are sold for cash and delivered immediately. ...

Finance series Financial market Financial market participants Corporate finance Personal finance Public finance Banks and Banking Financial regulation Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. ... This article does not cite any references or sources. ... There are two basic financial market participant catagories, Investor vs. ... Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. ... This article does not cite any references or sources. ... For other uses, see Bank (disambiguation). ... Financial supervision is government supervision of financial institutions by regulators. ...

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A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated. It is used to control and hedge risk, for example currency exposure risk (e.g. forward contracts on USD or EUR) or commodity prices (e.g. forward contracts on oil). It has been suggested that this article or section be merged into Hedge (finance). ... The United States dollar is the official currency of the United States. ... For other uses, see Euro (disambiguation). ... This article does not cite any references or sources. ... Pumpjack pumping an oil well near Lubbock, Texas Ignacy Łukasiewicz - inventor of the refining of kerosene from crude oil. ...

One party agrees (obligated) to sell, the other to buy, for a forward price agreed in advance. In a forward transaction, no actual cash changes hands. If the transaction is collateralized, exchange of margin will take place according to a pre-agreed rule or schedule. Otherwise no asset of any kind actually changes hands, until the maturity of the contract. The forward price is the agreed upon price of an asset in a forward contract. ... In finance, a margin is collateral that the holder of a position in securities, options, or futures contracts has to deposit to cover the credit risk of his counterparty. ... For schedule in computer science, see schedule (computer science). ... Maturity may refer to: Sexual maturity Maturity, a geological term describing hydrocarbon generation Maturity, a financial term indicating the end of payments of principal or interest Look up Maturity in Wiktionary, the free dictionary. ...

The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands (on the spot date, usually two business days). The difference between the spot and the forward price is the forward premium or forward discount. The spot price of a commodity or a security or a currency is the price that is quoted for settlement (payment and delivery) of the transaction immediately. ... A business day is a duration of time standardized to the seven-day work week, used to differentiate calendar days, based on a seven-day week, from the time period when a company is in operation. ... Look up premium in Wiktionary, the free dictionary A Premium may refer to: Premium rate telephone number, the UK Premium Bond Premium outlet Risk premium, in finance, the monetary difference between the guaranteed return and the possible return on an investment This is a disambiguation page — a navigational aid which...

A standardized forward contract that is traded on an exchange is called a futures contract. In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. ...

Example of how the payoff of a forward contract works

Suppose that Bob wants to buy a house in one year's time. At the same time, suppose that Andy currently owns a $100,000 house that he wishes to sell in one year's time. Both parties could enter into a forward contract with each other. Suppose that they both agree on the sale price in one year's time of $104,000 (more below on why the sale price should be this amount). Andy and Bob have entered into a forward contract. Bob, because he is buying the underlying, is said to have entered a long forward contract. Conversely, Andy will have the short forward contract.

At the end of one year, suppose that the current market valuation of Andy's house is $110,000. Then, because Andy is obliged to sell to Bob for only $104,000, Bob will make a profit of $6,000. To see why this is so, one needs only to recognize that Bob can buy from Andy for $104,000 and immediately sell to the market for $110,000. Bob has made the difference in profit. In contrast, Andy has made a loss of $6,000.

Example of how forward prices should be agreed upon

Continuing on the example above, suppose now that the initial price of Andy's house is $100,000 and that Bob enters into a forward contract to buy the house one year from today. But since Andy knows that he can immediately sell for $100,000 and place the proceeds in the bank, he wants to be compensated for the delayed sale. Suppose that the risk free rate of return R (the bank rate) for one year is 4%. Then the money in the bank would grow to $104,000, risk free. So Andy would want at least $104,000 one year from now for the contract to be worthwhile for him. But Bob knows that if he buys the home now, having to take out a loan of $100,000, he will be required to pay back $100,000 plus 4% interest. Thus, entering into a forward contract now means that he doesn't have to pay this interest. Bob will be willing to go at least as high as $104,000 for a purchase in one year's time.

Rational pricing

If S_t is the spot price of an asset at time t, and r is the continuously compounded rate, then the forward price must satisfy F_t,T = S_te^{r(T − t)}. The spot price of a commodity or a security or a currency is the price that is quoted for settlement (payment and delivery) of the transaction immediately. ...

To prove this, suppose not. Then we have two possible cases.

Case 1: Suppose that F_t,T > S_te^{r(T − t)}. Then an investor can execute the following trades at time t:

1. go to the bank and get a loan for S_t at the continuously compounded rate r;
2. with this money from the bank, buy one unit of stock for S_t;
3. enter into one short forward contract costing 0. A short forward contract means that the investor owes the counterparty the stock at time T.

The initial cost of the trades at the initial time sum to zero.

At time T the investor can reverse the trades that was executed at time t. Specifically, and mirroring the trades 1., 2. and 3. the investor

1. ' repays the loan to the bank. The inflow to the investor is − S_te^{r(T − t)};
2. ' sells the stock for S_T. The cash inflow to the investor is now S_T.
3. ' settles the short forward contract by receiving S_T from the buyer; there is an inflow of funds to the investor of F_t,T − S_T.

The sum of the inflows in 1.', 2.' and 3.' equals F_t,T − S_te^{r(T − t)}, which by hypothesis, is positive. This is an arbitrage profit. Consequently, and assuming that the non-arbitrage condition holds, we have a contradiction. This is called a cash and carry arbitrage because you "carry" the stock until maturity.

Case 2: Suppose that F_t,T < S_te^{r(T − t)}. Then an investor can do the reverse of what he has done above in case 1. But if you look at the convenience yield page, you will see that if there are finite stocks/inventory, the reverse cash and carry arbitrage is not always possible. It would depend on the elasticity of demand for forward contracts and such like. A convenience yield is an adjustment to the cost of carry in the non-arbitrage pricing formula for forward prices in markets with trading constraints. ...

Extensions to the forward pricing formula

Suppose that PV_T(X) is the time value of cash flows X at the contract expiration time T. The forward price is then given by the formula: The forward price is the agreed upon price of an asset in a forward contract. ...

The cash flows can be in the form of dividends from the asset, or costs of maintaining the asset. It has been suggested that ex-dividend date be merged into this article or section. ...

If these price relationships do not hold, there is an arbitrage opportunity for a riskless profit similar to that discussed above. One implication of this is that the presence of a forward market will force spot prices to reflect current expectations of future prices. As a result, the forward price for nonperishable commodities, securities or currency is no more a predictor of future price than the spot price is - the relationship between forward and spot prices is driven by interest rates. For perishable commodities, arbitrage does not have this In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ...

The above forward pricing formula can also be written as:

F_t,T = (S_t − I_t)e^{r(T − t)}

Where I_t is the time t value of all cash flows over the life of the contract.

Theories of why a forward contract exists

Allaz and Vila (1993) suggest that there is also a strategic reason (in an imperfect competitive environment) for the existence of forward trading, that is, forward trading can be used even in a world without uncertainty. This is due to firms having Stackelberg incentives to anticipate their production through forward contracts. The Stackelberg leadership model is a strategic game in economics in which the leader firm moves first and then the follower firms move sequentially. ...

See also

• Futures contract
• Derivative (finance)
• Forward market
• Hedging
• Option
• Swap (finance)
• 988 transactions
• Non-Deliverable Forwards

In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. ... Derivatives traders at the Chicago Board of Trade. ... The forward market describes the over the counter market in contracts for future delivery or, in physical commodities, for later shipment. ... It has been suggested that this article or section be merged into Hedge (finance). ... In finance options are types of derivative contracts, including call options and put options, where the future payoffs to the buyer and seller of the contract are determined by the price of another security, such as a common stock. ... For the Thoroughbred horse racing champion, see: Swaps (horse). ... An IRC 988 transaction is when you enter into or acquire any forward contract, futures contract, option, or similar financial instrument. ... Non-Deliverable Forwards (NDF) are a kind of financial instrument used in various markets such as foreign exchange and commodities. ...

References

• John C. Hull, (2000), Options, Futures and other Derivatives, Prentice-Hall.
• Keith Redhead, (31 Oct 1996), Financial Derivatives: An Introduction to Futures, Forwards, Options and Swaps, Prentice-Hall
• Abraham Lioui & Patrice Poncet, (March 30, 2005), Dynamic Asset Allocation with Forwards and Futures, Springer

Further reading

• Allaz, B. and Vila, J.-L., Cournot competition, futures markets and efficiency, Journal of Economic Theory 59, 297-308.