Stock Index Futures Prices Essay Example | Topics and Well Written Essays - 2000 words

Stock Index Futures Prices - Essay Example Arbitrage is also characterised as the simultaneous buying and selling of stocks in two separate financial markets with the intention of making profits generated by the difference between the buying and the selling prices of a commodity(Sackman, and Coltman 1996, 25). The carry cost can also be described as the interest expense paid by the investor to hold on to the commodity purchased in the futures market until the maturity date of the futures contract(Bjrk 2004, 1). Arbitrage will be further discussed below. Many investors prefer to funnel their scarce money resources into a cash and carry arbitrage contract. Their real goal would probably be to invest in two securities that are differently priced in the market. Later, the stock or futures prices of both commodities will correct themselves by either decreasing or increasing. This movement of prices would cause a profit on one commodity and a loss on the other commodity. Both these commodities will smoothen out resulting to the avoidance or decrease of probable future losses. The commodities where arbitrage can be used include sugar, gold, silver, coffee, oil, U.S. dollar currency, European dollar currency, Japanese Yen, French Franc, and other currencies (Scobie, Buckley, and Fox 1998, 8) In addition, the arbitrage investor may generate profits from investments if he or she invests in a security or in the futures contracts. The investor would then profit when the amount of the of the commodity plus the added cost of carrying is less than the projected commodities futures prices. One clear advantage of using arbitrage in the commodities futures market is that the investors can sell a commodity like the United States dollar today and then buy the same foreign currency four days after the currency purchase date. On the other hand, this is not possible in the real world. The real world transaction is characterised by a sales person turning over to the buyer the car, house, shirt, or computer game the moment when he or she pays for the items bought. Only when the sales price is higher than the investment price will the investor harvest the fruits from his or her arbitrage investment. In terms of the oil industry, "The oil industry, more than other energy sectors, is globa l in its character and operations. The geographical concentration of reserves and the vital role of oil in modern society has made it the principal commodity in international trade" (Haugland, Bergesen, and Roland 1998, 54) Evidently, the arbitrage investor may generate profits from investments if he or she invests in a security or in the futures contracts. Likewise, FRA influences prices. The currency exchange rate of the Eurodollar futures and American dollar Foreign Rate Agreements (FRA) high frequency data clearly indicates that the countless arbitrage opportunities are linked to the presence of stale FRA commodity prices as well as the oscillatory behavior of FRA quotes. And, Inter -market information flows are found to be of much shorter duration than previously reported with the futures market playing the dominant role in the information transmission process in the shorter -dated maturities. Many investors inject their money in short term interest rate futures and forward rate