Many farmers for example have long sold their crop in advance to a predetermined price using futures contracts. That way they have been able to know exactly how much they will get paid, providing stability for their business and enabling them to focus on their core business activities. Speculators take on the risk of losing money on the spot market (in contrast to futures deals, spot deals involve immediate deliveries of securities or commodities) for the farmers in return for the possibility of earning significant returns if the spot price is higher
Similarly, companies that sell and/or buy from suppliers and/or customers in other currency zones can trade away the risk that they will get less paid or will have to pay more than they think by already selling or buying using futures contracts. As in the previous example, this means that risk is transferred from buyer to seller. As was noted in the chapter on the euro, the existence of such contracts significantly reduces (although it doesn’t eliminate it) the problem of currency risk, and so help increase global competition. Studies suggest that the use of currency derivatives help boost company growth30.
As derivatives thus transfer risk from hedgers to speculators, they could thus be seen as a form of insurance market, where speculators act as insurance companies selling insurances to hedgers. The “insurance premium” consists in speculators getting the upside potential if things go even better than expected. In the case of options and warrants though, the buyer of the “insurance” keeps the upside potential and instead pays a direct premium for getting relieved of the downside risk.
The existence of options and warrants can for this reason help bring in new investors to the stock market. Say you want to own a stock of say Ericsson, yet given that stock’s high historical volatility, you are afraid of potentially losing a lot of money. What you can do then is to buy a sell option, commonly known as a put, that gives you the right, but not the obligation to sell a stock (in this case Ericsson) for a pre-determined price at (or in the case of American options before) a pre-determined date, regardless of what the spot price might be at that date. That way,
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