The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
September 15, 1978
Dovv-Jones
Futures
Futures markets, which are markets in
contracts promising delivery of goods
or assetsat some specified date, have
been marked by controversy throughout the century of active trading in this
country. The issuein question was, and
remains, the benefits or costs which
these markets provide to society as a
whole.
The KansasCity Board of Trade has recently proposed a new futures market - a market in the 30-stock DowJonesindustrial average. This proposal
promises to be controversial, since a
D JImarket would not provide the potential social benefits economists have
traditionally ascribed to older commodity-futures markets. New social
benefits may be possible with such a
market, however, as we shall see below. A second article will discuss another interesting possibility - a futures
market for consumer prices.
Benefits of commodity futures
Economists have long maintained that
the traditional futures markets in farm
commodities provide substantial social benefits. Those benefits are the
mirror images of two basic problems
implicit in commodity spot markets.
First, spot-market prices fluctuate violently and unpredictably, making investment in farm commodities a very
risky business. Second, farmers as a
group tend to be risk averse, but by
the very act of farming are forced to
bear the risk that the price of their
crop will fall. By selling futures contracts, however, farmers can trade
away the risk involved in farming to
those who are less risk averse, without giving up farming itself.
Futures markets thus generate social
benefits when two factors are present:
(1) a spot market characterized by
large and unpredictable price fluctuations, and (2) a large group of riskaverse·individuals who wish to avoid
the risk of trading in the spot market.
With these two ingredients, the riskaverse participant can trade away his
exposed position to others more iiterested in taking a risk.
Spot-market volumes associated with a .
futures market must be large, both to
insure that the social benefits from the
futures market are substantial and to
prevent a single trader from cornering'" the market. Federal Reserve
Chairman Miller made this point recently in discussing a proposal by the
Chicago Mercantile Exchange to trade
futures in longer-term Treasury bills
and notes.
volume of bill.savailable to private domestic investors in
the one-year bill auctions has, at times,
ranged down to only about $1 billion, '" he said.
there is concern
that a speculator with substantial resources and a large long position in the
(continued on page 2)
IPC8cdice1
f@\ll
1&C&,rrli
J1\\
C8CD,\,
-"",lJ1i
futures market could capture a sufficient share of the new issue in the auction in order to profit from price
advances between the auction and delivery of the new bill- on both his futures contracts and his awards of the
N
bill.
Why Dow-Jones
futures?
There are two differences between
the proposed Dow-Jones futures and
ordinary commodity-market futures
- a technical difference and an economic difference. The technical difference is that the D JI futures market
would not have a corresponding spot
market. Rather, the return on this contract would be tied to the entire 30stock industrial average, with many
spot markets determining the value of
the average. So there would be many
spot markets instead of only one corresponding to this futures market.
The economic difference is that D JIfutures would lack one of the two ingredients of commodity-futures markets
that usually lead to social benefits - a
large group of risk-averse traders who
want to cover an exposed position on
the spot market. An individual with an
exposed position in stocks is not risk
averse, because the stock market is
the natural home of the risk seeker.
The demand for low-risk corporate
assets can be met by an alternative
form of capital, that is, fixed-income
securities.
2
Nonetheless, a potential social gain exists, because the D JIfutures market enables investors to choose among
different types of risk. Different factors
influence the price of a given share of
stock - some affecting stocks in general, and some affecting only a particular
firm's stock. Any number of events,
from a rise in oil prices to a change in
monetary policy, might affect stock
values generally. But more specific
. events, such as a firm's own management decisions, would tend to affect
that firm's stock value alone. By selling
a DJI futures contract and buying
shares in a particular stock, investors
could
price risk,
thereby separating the risk specific to a
particular stock from the price risk of
the stock market as a whole.
50r:ne investors would have a strong
incentive to sell Dow-Jones futures
contracts. These investors, by choosing the right combination of purchases
of some specific stock and sales of D JI
futures, could bet on the performance
of one firm relative to the market as a
whole. An investor who had specific
information about the quality of the
management of a particular firm, but
no special talent for forecasting the
economy as a whole, could obtain several significant benefits with his portfolio of securities. First, he could be
protected from fluctuations of the
overall stock market, but he could also
reap the benefits of specialized
knowledge of one particular corporate
stock.
Suppliers of Dow-Jones futures might
by their very existence create further
indirect social gains. Since sellers of
such futures would be protected from
general market factors but exposed to
factors affecting the stock of a particular firm, they would tend to put greater
pressure on corporate managers to
improve their individual performance
vis-a-vis competitors.
One final ingredient is necessary to ensure the necessary social benefitsthe existence of a large class of investors who are interested both in avoiding the risks of holding individual stocks
and in assumingthe risksgenerated by
the market as a whole; in other words,
buyers of DJI futures. However, the
interest of this group is already assured. This is because the Dow-Jones
futures contract would have many of
the characteristics of a product of
proven appeal- the index fund. Index
funds are mutual funds that attempt to
mirror the market as a whole. Their
chief characteristic is that they hold
widely diversified portfolios that are
changed infrequently, so that fees for
expert advice and trading commissions
are kept to a minimum.
In one respect, DJI futures would improve upon index funds, because the
only expenses involved would be
those from trading the contract itself.
On the other hand, DJI futures trading
would suffer from the deficiencies of
the Dow-Jones average itself. In other
words, it would provide a weaker reflection of the overall stock market
than some broader measure, such as
the Standard and Poor's index of 500
stocks.
Kurt Dew
Copies are now available of the Academic Conference Proceedings of the
West Coast Academic/Federal Reserve Economic Research Seminar. The Proceedings examine, first, the effects of expectations formation on some basic
propositions of macroeconomics, and second, the behavior of financial institutions over the business cycle. Five research papers by West Coast academic
economists (along with discussion notes) are included in the volume. The Proceedings are aimed primarily at an audience of financial analysts and academic
economists . . . Free copies of the Proceedings can be obtained by calling or
writing the Public Information Section, Federal Reserve Bank of San Francisco,
P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184.
3
UOl8u!4SI:
M" 41:ln .. uo8aJO .. I:pl:I\aN • o41:PI
!!I:MI:H .. I:!UJOJ!
W:)
I: UOZ!JV" 1:>lsl:lV
'j!le:) 'o: JspueJ:I ueS
(,;SL:' O N
OI Vd
:I9Vl S Od
llVW SSV1:)
@Lffi.Jr@<§@CQI
's'n
{1
BANKING DATA-TWE LFTH FEDERALRESERVE
DISTRICT
(Dollar amounts in millions)
Selected Assets and liabilities
large Commercial Banks
Loans (gross, adjusted) and investments*
Loans (gross, adjusted) - total
Security loans
Commercial and industrial
Real estate
Consumer instalment
U.s. Treasury secur.ities
Other securities
Deposits (less cash items) - total*
Demand deposits (adjusted)
U.s. Government deposits
Time deposits - total*
States and political subdivisions
Savings deposits
Other time depositst
Large negotiable CD's
Weekly Averages
of Daily Figures
Member Bank Reserve Position
ExcessReserves(+)/Deficiency (-)
Borrowings
Net free( +)/Net borrowed (-)
Federal Funds-Seven large Banks
Interbank Federal fund transactions
Net purchases (+)/Net sales(-)
Transactions with U.s. security dealers
Net loans (+)/Net borrowings (-)
Amount
Outstanding
Change
from
8130178
8123/78
116,023
93,691
1,809
27,803
32,437
17,112
8,664
13,668
111,721
30,750
233
78,966
6,6'17
31,570
37,582
18,274
+
+
-
+
+
+
-
+
+
+
-
+
+
-
+
+
Change from
year ago
Dollars
Percent
+
+
+
+
+
+
+
321
277
93
17
189
116
26
70
940
593
21
384
15
113
255
450
-
+
+
+
+
+
-
+
+
Week ended
Week ended
8130178
8123178
+
31
38
69
+
85
61
24
+
491
+
1,194
681
+
347
16,109
16,347
100
4,013
6,909
3,700
247
485
13,501
2,514
20
10,983
1,315
139
8,618
6,984
+
+
+
+
+
+
+
-
+
+
+
+
+
-
+
+
16.12
21.14
5.85
16.87
27.06
27.59
2.93
3.43
13.75
8.90
9.39
16.16
24.80
0.44
29.75
61.86
Comparable
year-ago period
+
59
124
65
146
+
576
*Includes items not shown separately. tlndividuals, partnerships and corporations.
Editorial comments may be addressed to the editor ( William Burke) or to the author, , , .
Free copies of this and other Federal Reserve pUblications can be obtained by calling or writing the Public
Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone
(415) 544-2184.
@FedFRASER