02 April 2011

Commodities and Their Derivatives

You'll remember that my March 12 blog entry consisted of a discussion of what is to become the fourth chapter of my proposed book as represented in the table of contents I provided in this blog on December 10, 2010. Now I move to the fifth chapter, about commodities and their derivatives.

This will make five points.

1. definition of terms

A commodity in the sense significant for this book is a physical (and usually a fungible) item of commerce. It is distinct from intangible goods such as patent rights, or a share of equity in a company. It is also usually distinct from any complicated manufactured item, such as a custom-built hot rod. Foods, metals, and natural fibers are all commodities.

2. Brief history of the derivatives exchanges

Commodity futures are the paradigmatic "derivatives." Birth of the Chicago Board of Trade. The CME and a cross-time rivalry. Imitators and developments.

3. Federal regulation up to 1974

Federal regulation of futures contracts began with the Futures Trading Act of 1921. Declared unconstitutional by SCOTUS later that year. How this decision was circumvented and the regulatory system established. Why it took another 50 years for the system to crystallize into the CFTC.

4. the OTC derivatives market and its challenge to the exchanges

One distinction between OTC and exchange trading involves the margin requirements of the latter: performance bonds that market participants must post, in amounts that vary in a way based on the risk and volatility of the product. In the OTC market there have long been no rules, so the parties negotiate their own collateral arrangements. Dodd-Frank. What happens next?

5. It is time now to deal with the spectre of speculation.

Speculation is not gambling. Why not? Because gambling creates its own risk for the sake of the game. A gambler puts money on how a pair of dice will land. Nobody would even bother rolling those dice unless somebody was putting money on them.

What about sports gambling? The game exists independent of the risk. We might suppose that basketball games will continue to take place even in a (hypothetical) world in which gambling on basketball comes to a quick and complete end. But the game itself is not a risk for the folks in Vegas putting their money on the line. It becomes a risk when they decide to accept that risk, both for the chance of profit and for the thrill.

How is that different from financial and commodity speculation? Consider orange juice futures, the subject of a memorable Eddie Murphy and Dan Ackroyd collaboration. These risks are not optional. Anyone investing in an orange grove, in the expectation of selling the fruit of his labors to the OJ market is taking enormous risks. The “dice” are meteorology on the one hand and fickle breakfasting-consumer preferences on the other. The producers can only hedge these risks to the extent that speculators are willing to take it from them.

6. Our first look at the CBOT/CME merger of 2007. We'll come back to this.


Blogger said...

eToro is the #1 forex trading platform for beginner and pro traders.

Blogger said...

There's shocking news in the sports betting industry.

It's been said that every bettor needs to look at this,

Watch this or quit placing bets on sports...

Sports Cash System - Advanced Sports Betting Software.

Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see www.proxypartisans.blogspot.com.