The assignment deals with the question whether derivatives harm society as a whole. The central issue is a possible impact of derivatives prices on present prices for agricultural commodities. In order to provide the necessary background knowledge, the terms derivatives, varieties, valuation, market participants and principles of operation are explained. After recognising theoretical knowledge and the results of different studies, it turns out that there is no empirical evidence for plausible harming impacts of over speculating index investors. Further studies have to be conducted in future in order to provide a reliable proof for policy makers.
Table of Contents
1. Introduction
2. Derivatives Defined
3. Types of Derivatives
3.1 Forwards
3.2 Futures
4. Conceptual Insights and Valuation
4.1 Main Mechanisms of a Futures
4.2 Valuation Concept
4.3 Relationship between Spot Markets and Futures Markets
5. Markets, Participants and their Intentions
6. Derivatives on Agricultural Markets and their Impacts
6.1 Market Characteristics
6.2 Analysis of the Link to Increased Food Prices
6.3 Conclusion
7. Result and Critical Appraisal
Objectives and Research Focus
This academic assignment investigates the complex relationship between financial derivatives and agricultural commodity prices to determine whether such trading instruments provide social utility or inflict economic harm. It specifically addresses the controversial role of index investors in global food markets and evaluates the theoretical and empirical arguments surrounding market speculation.
- Technical definition and operational principles of forwards and futures.
- Mechanisms of valuation and the relationship between spot and futures markets.
- Categorization of market participants and their respective motivations.
- Critical analysis of the empirical evidence regarding the link between financial speculation and food price volatility.
Excerpt from the Book
6. Derivatives on Agricultural Markets and their Impacts
After having built a theoretical framework for discussing the main reproach that trading with derivatives partially contributes to increasing food prices, an analysis will be given in this chapter (Bass 2013, p. 8). As a first step the peculiarities of food markets with regard to price volatility will be shown in order to distinguish between normal and abnormal fluctuation.
Typically underlying assets of agricultural markets are corn, wheat, soybeans, rice, cocoa, coffee, cotton or products related to livestock. A lot of these products are input resources for groceries. So basically the two forces supply and demand lead to a price, which is perfectly balanced in the equilibrium of an efficient market (Mankiw and Taylor 2008, p. 76). If there is overdemand on a product, for instance through a rise in population or income, the price will go up. The same will happen if there is undersupply leading to a shortage. Moreover the prices are influenced by a stocks-to-use ratio, that reflects how much of resources are in stock or in other words extracted from the active market. Additionally, prices are subject to seasonal fluctuation through changes of weather or storage costs. Effects of inflation as a general rise of price levels are neglected (Chance and Brooks 2010, p. 275).
Chapter Summaries
1. Introduction: Presents the debate regarding whether derivatives influence global food prices and outlines the paper's central research question.
2. Derivatives Defined: Establishes the technical definition of derivatives as financial instruments whose value is derived from an underlying asset.
3. Types of Derivatives: Provides an overview of forward and futures contracts and their usage in agricultural markets for risk management.
4. Conceptual Insights and Valuation: Explains the mechanisms of futures trading, the carry arbitrage model, and how contracts are valued in an efficient market.
5. Markets, Participants and their Intentions: Details the roles of hedgers, speculators, market makers, and arbitrageurs in maintaining market efficiency.
6. Derivatives on Agricultural Markets and their Impacts: Analyzes the debate over whether speculative capital flow influences spot prices and investigates index investment.
7. Result and Critical Appraisal: Concludes that while no final empirical consensus exists, derivatives are essential for farmers' risk transfer despite concerns about speculative demand.
Keywords
Derivatives, Agricultural Commodities, Futures, Forwards, Hedging, Speculation, Market Efficiency, Index Investors, Price Discovery, Spot Markets, Financialization, Carry Arbitrage, Food Prices, Risk Management, Market Participants
Frequently Asked Questions
What is the primary purpose of this assignment?
The assignment aims to determine whether trading derivatives on agricultural commodities acts as a benefit (charm) or a detriment (harm) to society, particularly concerning food price stability.
What are the main thematic pillars discussed?
The work covers the definition of financial instruments, their operational valuation, the distinct roles of market participants, and the empirical link between speculation and rising food costs.
What is the core research question addressed?
The central question is: Are derivatives on agricultural markets a harm or a charm for society?
Which scientific methods are utilized in the work?
The paper relies on a comprehensive literature review and theoretical framework analysis, discussing empirical findings such as the granger-causality method to evaluate market relationships.
What does the main body focus on?
The main body moves from technical definitions of forwards and futures to the practical application of the carry arbitrage model and a critical review of the "financialization" of commodity markets.
How are the key terms defined?
Keywords reflect the intersection of financial theory and agricultural economics, highlighting concepts like hedging, speculation, and price discovery mechanisms.
What specific role do 'index investors' play in the author's analysis?
The author discusses how index investors, who do not trade based on physical supply and demand, are criticized for potentially distorting market prices through high-volume long positions.
What conclusion does the author reach regarding the impact of derivatives?
The author concludes that derivatives provide essential value for farmers through risk transfer (hedging), but notes that empirical evidence regarding their role in food price spikes remains inconclusive due to flawed data and lack of consensus.
- Arbeit zitieren
- Martin Wendt (Autor:in), 2014, Derivatives on Agricultural Commodities. Harm or Charm for the World's Society, München, GRIN Verlag, https://www.grin.com/document/274334
