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Learn about the Participants of Derivatives Market : Hedgers, Arbitragers & Speculators

Published : August 28, 2017

Learn about the Participants of Derivatives Market : Hedgers, Arbitragers & Speculators

We all are familiar with the features of Financial Markets, through which banks, corporate and Government raise or deploy money to meet their requirements. Among all the markets Primary Market is used for raising money and secondary market is used for trading securities which have been issued in the primary markets.

Derivative Market is quite different from other markets, as it is used to minimize the risk arising from the underlying assets. Let’s see what a Derivative Market is and how it helps in minimizing the risk.

The word ‘Derivative’ originates from mathematics; it refers to a variable which has been derived from another variable. A financial derivative is a product derived from the market of another product.

Hence derivative market has no independent existence without an underlying commodity or asset. The price of the derivative instrument is contingent on the value of its underlying assets.

Derivatives are designed to manage risk, which arises from movements in markets. The Derivative Markets enable institutional investors, bank treasurers and corporate to manage their risk more efficiently and allow them to hedge or speculate on markets.

Participants of Derivatives Market:

Generally, Banks, Corporates, Financial Institutions, Individuals, and Brokers are seen as regular participants to hedge, speculate or arbitrage in the markets. The participants can be classified into three categories based on the motives and strategies adopted.Learn about the Participants of Derivatives Market : Hedgers, Arbitragers & Speculators

  1. Hedgers:

Hedging is an act, whereby an investor seeks to protect a position or anticipated position in the spot market by using an opposite position in derivatives. The parties perform hedging are known as hedgers.

In the process of hedging, parties such as individuals or companies owning or planning to own a cash commodity like corn, pepper, wheat, treasury, bonds, notes or bills etc. are concerned that the cost of the commodity may change before either buying it in the cash market.

They want to reduce or limit the impact of such movements, which, if not covered, would incur a loss. In such situation, the hedger achieves protection against changing prices by purchasing or selling futures contracts of the same type and quantity.

Similar objectives can be achieved with options. If the price of an asset is intended to fall then put options may be purchased and if it is likely to rise, a call option can be purchased.

  1. Speculators:

Speculators are basically traders, who enter the futures and options contract, with a view to make profit from the subsequent price movements.They do not have any risk to hedge; in fact they operate at a high level of risk in anticipation of profits. Speculation provides liquidity in the market.

The speculators also perform a valuable economic function of feeding information which is not readily available elsewhere, and help others in analyzing the derivatives markets.

  1. Arbitragers:

The act of obtaining risk free profits by simultaneously buying and selling similar instruments in different markets is known as ‘arbitrage’. The person who does this activity is referred to as an ‘arbitrageurs’.

For example, One can always sell a stock on NSE and Buy on BSE.

The Arbitrageurs continuously monitor various markets, and wherever there is a chance of Arbitraging, they buy from one market and sell in the other market. In this way, they make a riskless profit.

They keep the prices of derivatives and current underlying assets closely consistent and perform a valuable economic function.

Arbitragers and Speculators perform almost a similar function since they do not have any risk to hedge. They help in identifying inefficiencies that exists among the markets.

While arbitragers help in price discovery leading to market efficiency. Speculators help in enhancing the liquidity in the market.

 

 

 

 

 

 

 


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