Question

3. The stock market has swung wildly due to fears of economic damage caused by the Covid-19 outbreak. On March 5, 2020, an article in the Wall Street Journal observed that “futures linked to the Dow Jones Industrial Average fell 1.8%, suggesting that the gauge for blue-chip stocks may open over 500 points lower when trading opens in New York”. Why might falling futures be an indication that DJIA might fall after market opens? Use what we have learned about futures price and spot price to explain.

Answer 1

• Futures related to a company means a standardized legal contract to buy or sell an underlying asset, which is usually a financial instrument or a commodity such as crude oil, wheat, natural gas, gold, etc at predetermined prices in future. It is a right to buy and obligation to sell.
• Future prices is predetermined price of a commodity or financial instrument which is to be bought or sold in future under future contracts.
• Spot price is the price of a commodity or financial instrument which is bought or sold on the spot with immediate delivery. In spot contracts, there is only the right to buy or sell, but no obligation to buy or sell.
• Futures are basically used by the investor to hedge the prices and prevent future loss possibility. They lock in the prices of underlying asset today for a contract to be executed in the future. It is based on pure speculation of price movements of the underlying assets.
• The fall in prices of stocks of a company is based on various market factors. It is not solely based upon the prices of futures of that company.
• Depending upon the market conditions, the prices of stocks of a company fluctuates.
• The fall in the prices of futures of DGIA might be because of the global market fall due to outbreak of COVID-19 pandemic.
• So it might be possible that the blue-chip stocks of the company might also fall. But this is not solely dependent upon the fall in prices of future of DGIA.
• The factors which affect the future prices are as follows:-

1. The cost of storage of underlying asset.
2. The rate of interest.
3. The change in spot price of the underlying asset, etc.

• So it can be said that the spot prices of underlying asset may affect the future prices of the company.
• But the changes in future prices of the company may or may not have any influence over the spot prices in the stock market.
• The stock prices of DGIA is mainly affected due to fall of global market as a whole, which is due to spread of pandemic COVID-19 and crude oil war between Saudi Arabia and Russia.
• Other factors influencing the stock market prices are as follows:-

1. Natural calamities and disasters which can be man made or natural.
2. Economic factors like employment rate, interest rate, economic growth, inflation rate, etc.
3. Political issues and market psychology.
4. Pandemic and endemic diseases.