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DERIVATIVES MARKETS

Since the securities are listed and traded in the stock exchange, the secondary market is also called the stock market. In primary market, companies interact with investors directly while in the secondary market investors interact with themselves. In both cases, the capital market intermediaries play an important role .The secondary market, based on all available information, determines the price and risk of the issued securities, it provides useful signals to both listed companies and investors to act in the primary markets. The secondary market may also include the over the counter market and the derivatives market. In the stock market share prices are determined by the demand and supply forces. On the other hand, in the over the counter market prices are negotiated between the buyer and the seller. The derivatives market deals in futures and options. In the derivatives markets, securities or portfolios of securities are traded for future delivery. In case of options, the future delivery is conditional as the buyer has a right to exercise or not to exercise the option. The derivatives market and my proposed derivative product The emergence of new markets for derivatives such as forwards and futures can be traced back to the willingness of risk adverse economic agents to protect themselves against uncertainties occurring from price fluctuations in various asset categories. Naturally, financial markets are very volatile. Through derivative products, however, it is possible to fully or partially transfer price risks by locking in prices of assets. By doing so derivative products reduce the impact of fluctuations in prices of assets on the cash flow and profitability situation of risk averse investors (Morrison and Winston 34). The derivative instruments are in use by all business sections, for instance, corporates, SMEs, financial institutions, banks and retail investors. My motivation for this derivative is the ability to trade while conserving the environment through the hampering of the big problem of global warming which is getting worse as firms continue to produce. The trading is also focused on trading carbon credits with the aim of controlling or reducing pollutants produced from business activities of firms. Therefore, the central driver of carbon emissions trading would be the impact on the climate and the degradation of the environment as a result of emissions of various gases. The immaturity of this market of derivatives also gives hope that there is a growth potential for this business. Currently there are smaller numbers of firms that offer such certificates. An appropriate pricing model for derivatives on the carbon emission certificates is certainly the first step in coming up with the derivative there is need to investigate the price dynamics. Product Design and Specifications The proposed derivative is a futures contract. Via the American Climate Exchange (ACX) carbon derivatives will be based upon 3 types of carbon related units. The following table gives an overview of my product in terms of price, quantity, unit of underlying asset, maturity date, delivery policy, margin requirement and daily settlement and transaction costs. Type Carbon Emission Derivation: futures contract Trading Units 1000 carbon dioxide EUA allowances, with each allowance allowing 1 tonne of carbon dioxide equivalent gas Minimum trading 1 lot Strike Price Intervals Quotation US dollar per metric tonne Minimum Tick $ 0.01 per tonne Minimum price flux $0.01 ...Show more

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Date Question #1 [Derivatives Markets and Financial Innovations] Introduction Capital markets facilitate the free trading in all securities. It has two mutually supporting and indivisible segments: the primary market and the secondary market…
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