263
See also: Financial services 26–29 ■ Public companies 38 ■ Risk and uncertainty 162–63 ■
Behavioral economics 266–69 ■ Efficient markets 272 ■ Financial crises 296–301
At the same time domestic
economies were experiencing
steadily rising rates of inflation.
Keynesianism (pp.154–61), the
economic thinking that had
dominated the post-war years,
came under sustained intellectual
attack. The financial markets,
which had been tightly regulated
since the 1930s, pushed for a
removal of restrictions on their
activities. These restrictions were
finally lifted in 1972, when the
Chicago Mercantile Exchange was
allowed to write the first derivative
contract on exchange rates.
Futures contracts
Derivatives have existed for centuries.
A derivative is a contract written not
directly for a commodity itself, but
for some attribute associated with
it. For instance, a typical early
derivative contract is a “forward,”
which specifies the price and future
date for delivery of a commodity,
such as coffee. The advantage of
this arrangement is that it allows
producers to lock their customers
into a price in the future, regardless
of how—in agricultural commodities
—harvests and production actually
turn out. The derivative aimed toCONTEMPORARY ECONOMICS
reduce risk and insure against the
future. This is known as a “hedge.”
However, the derivative contract
can work the other way around.
Instead of providing insurance
against the future, it can be used
to gamble on the future. A forward
contract locks in the delivery of
goods for a certain price on a certain
date. But if the immediate market
price (the “spot price”) on that date
is less than the price in the forward
contract, an easy profit could be
made. Of course if the market price
is more than the one specified, it
results in a loss. Furthermore, as
derivative contracts do not involve
payment for actual assets or
commodities, but only for the right
to buy those products in the future,
they allow people to deal in huge
quantities. Derivatives give traders
leverage—more “bang for their buck.”Letting go of the asset
Derivative contracts became
standardized and could then be
bought and sold on a market like
any other commodity. The first ❯❯If we assume that financial
markets are efficient,
and prices will rarely
differ widely from
an average value...This means a contract
to buy goods at a future
price can be valued
accurately and used
to insure against risk.... the probabilities of
future price variations
can be calculated.It is possible to
invest without risk.The price of rice may vary with
changes in weather. A forward
contract, where one party agrees to buy
the rice at a certain price on a certain
day, allows the grower to manage risk.