chapter4 - Chapter 4 1 CHAPTER 4 Using Futures Markets In...

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Unformatted text preview: Chapter 4 1 CHAPTER 4 Using Futures Markets In this chapter, we discuss the different ways that futures markets serve different members of society. This chapter is organized into the following sections: 1. Price Discovery 2. Speculation 3. Hedging Chapter 4 2 Price Discovery Because the futures market incorporates the collective opinion of many buyers and sellers, the futures market can be used to reveal information about future spot prices. The usefulness of forecasting future spot prices, based on current futures prices, depends upon three factors: 1. Information : the need for information about future spot prices. 2. Accuracy : the accuracy of the futures market forecasts of those prices. 3. Performance : the performance of futures market forecasts relative to alternative forecasting techniques. Chapter 4 3 Information Interest Rates and Home Buying You are in the market for a new home and you want to have an idea of how interest rates will behave in the next year. By examining the WSJ, you can discover what the market as a whole thinks about the future course of interest rates. If the interest rate (yield) on bonds to be delivered in six months is three percentage points lower than current interest rates, then there is good reason to expect that interest rates will fall over the next six months. Furniture Manufacturer A furniture manufacturer needs to print its catalog for the next year and needs to include prices. Furniture prices will depend in part upon next year’s lumber prices. The furniture manufacturer can review the lumber futures market to estimate the costs of the wood. The person using the futures market to estimate the future course of interest rates or the future course of lumber prices is using the futures market for its price discovery benefit. Chapter 4 4 Accuracy We would like the estimator of the expected future spot price to be accurate. If it is not accurate, its usefulness is limited. A forecast estimate is unbiased if, on average, the forecast is correct. However, even if a forecast estimate is unbiased, the range might be so wide that its usefulness is limited. Example I predict that the points scored by the winner in the NBA finals game will be between 50 and 150 points. On average, I might be right, but the range is so wide that it not particularly useful. Futures prices sometimes have large errors and these may differ across commodities. Chapter 4 5 Performance Evidence suggests that while futures markets have large errors, they are generally better at predicting the future than any other available methods of forecasting. Because of this property, military researchers have suggested using futures contracts to predict terrorist attacks. Chapter 4 6 Forecasting Oil Prices A Case Study Table 4.1 illustrates a case of a large forecast error....
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This note was uploaded on 02/28/2010 for the course MBA 87 taught by Professor Dpg during the Spring '10 term at Indian Institute Of Management, Kolkata.

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chapter4 - Chapter 4 1 CHAPTER 4 Using Futures Markets In...

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