THE FINANCIAL FUTURES MARKET - ITS LINKS TO THE FINANCIAL CASH MARKET

Abstract

This study will attempt to give a historical account of the exchange rate regulations and the advent of the financial futures market. In recent years the volume of financial futures in foreign currencies traded on the futures market as indicated by its open interest positions had exceeded the volume of trades done on the foreign exchange cash market. Using a heavily traded currency, the Japanese Yen, this study will analyse if the prices determined in the futures market lead or lag the prices established in the foreign exchange market. This research is useful for the the purpose of understanding the practical aspects of arbitraging between the two markets and how the prices are transmitted from one market to another leading to a theoretical model of an integrated market. This study also seeks to understand the implications for market integration of forward and futures prices. There appears to be a high correlation of the prices established in the forward and futures markets. Hence, if the transaction costs are not taken into account, there does not appear to be any opportunity for profitable arbitrage. This suggests a close linkage of the markets.