Are the following statements consistent or inconsistent? Explain your answer and

Question

Are the following statements consistent or inconsistent? Explain your answer and discuss how equilibrium is achieved between the futures and cash markets.

1. Futures markets serve an important function of the global financial markets by giving investors the opportunity to better manage financial risks associated with their underlying business transactions.

2. The futures market is where price discovery takes place.

3. The introduction of futures contracts creates greater price volatility for the underlying commodity or financial asset.

Explanation / Answer

Futures markets are places where financial products like stocks and bonds are bought and sold , for a delivery at an agreed future date for prices agreed at the time of the deal.It also involves hedging and future interest rates.

The investor agrees to take on both the risks and rewards of the volatile market.So,the very purpose of futures trade is to avoid market volatility. Here,the point no.1 ,viz,Futures markets serve an important function of the global financial markets by giving investors the opportunity to better manage financial risks associated with their underlying business transactions is consistent with the definition and description of the futures market.

Hedgers enter the market with the sole purpose of ensuring future price. But speculators make profit out of and benefit from the risky nature of these markets.Hence markets fluctuate with wide uncertainties.

Cash market is cash on the spot and hence also called spot markets. As the time of delivery of the commodities dealt in the futures market nears, difference in their prices in the cash market and the futures market ,narrows or even tend to become equal.At maturity, the difference is zero. At this point , equilibrium is said to be achieved between the futures and cash markets.At the expiration of the futures contract ,equlibrium is achieved with the cash markets. fora particular product or commodity.

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