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Encyclopedia > Speculation

Speculation involves the buying, holding, and selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. Speculation or agiotage represents one of three market roles in western financial markets, distinct from hedging, long term investing and arbitrage. A fruit stand at a market. ... It has been suggested that shareholder be merged into this article or section. ... In finance, a bond is a debt security, in which the issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. ... The word commodity is a term with distinct meanings in business and in Marxian political economy. ... A collectible (or collectable) is a manufactured item designed for people to collect. ... Real estate is a legal term that encompasses land along with anything permanently affixed to the land, such as buildings. ... A derivative is a generic term for specific types of investments from which payoffs over time are derived from the performance of assets (such as commodities, shares or bonds), interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI) or an index of weather... Financial instruments package financial capital in readily tradeable forms - they do not exist outside the context of the financial markets. ... Dividends are payments made by a company to its shareholders. ... Interest is the rent paid to borrow money. ... A market is, as defined in economics, a social arrangement that allows buyers and sellers to discover information and carry out a voluntary exchange. ... In finance, financial markets facilitate: The raising of capital (in the capital markets); The transfer of risk (in the derivatives markets); and International trade (in the currency markets). ... It has been suggested that this article or section be merged into Hedge (finance). ... Investment is a term with several closely related meanings in finance and economics. ... In economics, arbitrage is the practice of taking advantage of a state of imbalance between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ...

Contents

Speculation areas

Convention - and especially satire - sometimes depicts speculators comically as speculating in pork bellies (in which a real market and real speculators exist) and often "losing their shirts" or making a fortune upon small market changes. Speculation exists in many such commodities but, if measured by value, the most important markets deal in financial futures contracts and other derivatives which involve leverage that can transform a small market movement into a huge gain or loss. Pork bellies are the underside of the hog, from which bacon is made. ... A derivative is a generic term for specific types of investments from which payoffs over time are derived from the performance of assets (such as commodities, shares or bonds), interest rates, exchange rates, or indices (such as a stock market index, consumer price index (CPI) or an index of weather... Leverage is related to torque; leverage is a factor by which lever multiplies a force. ...


Type of speculators

Most non-professional traders lose money on speculation, while those who do make money tend to become professionals. Occasionally some dramatic event will occur such as the effort of the Hunt brothers to corner the silver market or the currency speculations of George Soros. This article or section does not cite its references or sources. ... Nelson Bunker Hunt (born February 22, 1926 in Dorado, Arkansas) is an American businessman. ... General Name, Symbol, Number silver, Ag, 47 Chemical series transition metals Group, Period, Block 11, 5, d Appearance lustrous white metal Atomic mass 107. ... George Soros George Soros (pronounced ) (born August 12, 1930, in Budapest, Hungary, as György Schwartz) is a Jewish-American financial speculator, stock investor, and liberal political activist. ...


By some definitions, most long term investors, even those who buy and hold for decades, may be classified as speculators,[citation needed] excepting only the rare few who are not primarily motivated by eventually selling at a good profit. Some dedicated speculators are distinguished by shorter holding times, the use of leverage, by being willing to take short positions as well as long positions (in markets where the distinction can be reasonably made). A degree of speculation exists in a wide range of financial decisions, from the purchase of a house to a bet on a horse, this is what modern market economists call as Ubiquitous Speculation. Leverage is using given resources in such a way that the potential positive or negative outcome is magnified. ... It has been suggested that this article or section be merged with Short selling. ... In finance, a long position in a security, such as a stock or a bond, or equivalently to be long a security, means the holder of the position owns the security. ...


The economic benefits of speculation

The service provided by speculators to a market is primarily that by risking their own capital in the hope of profit, they add liquidity to the market and make it easier for others to offset risk, including those who may be classified as hedgers and arbitrageurs. In economics and marketing, a service is the non-material equivalent of a good. ... Capital has a number of related meanings in economics, finance and accounting. ... Market liquidity is a business or economics term that refers to the ability to quickly buy or sell a particular item without causing a significant movement in the price. ... Risk is a concept which relates to human expectations. ... In finance, a hedge is an investment that is taken out specifically to reduce or cancel out the risk in another investment. ... In economics, arbitrage is the practice of taking advantage of a state of imbalance between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ...


For example, if a certain market - say in pork bellies - had no speculators, only producers (pig farmers) and consumers (butchers etc) would participate in that market. With fewer players in the market, there would be a larger spread between the current bid and ask price of pork bellies. Any new entrant in the market who wants to either buy or sell pork bellies will be forced to accept an illiquid market and market prices that have a large bid-ask spread, or might even find it difficult to find a co-party to buy or sell to. A speculator (e.g. a pork dealer) may exploit the difference in the spread and, in competition with other speculators, reduce the spread thus creating a more efficient market. The bid/offer spread is the difference between the buying (bid) and selling (offer) price of the same stock or currency transaction. ... In finance, the efficient market hypothesis (EMH) asserts that stock prices are determined by a discounting process such that they equal the discounted value (present value) of expected future cash flows. ...


Another example of the value of speculators is the ability of a pig farmer to sell his pork on a futures exchange at a known price ahead of its production. A futures exchange, or futures and options exchange is a corporation or mutual organization which provides the facilities to trade derivatives such as futures contracts and options. ...


Some side effects

Auctions are a method of squeezing out speculators from a transaction, but they have their own perverse effects; see winner's curse. The winner's curse is however not very significant to markets with high liquidity for both buyers and sellers, as the auction for selling the product and the auction for buying the product occur simultaneously and the two prices are separated only by a relatively small spread. This mechanism prevents the winner's curse phenomenon from causing mispricing to any degree greater than the spread. Perverse effects of vaccination programmes manifest themselves when insufficient numbers of susceptibles are vaccinated to reach the critical threshold value (denoted qc) at which enough people are immune to the disease that its spread through the population (even to unvaccinated susceptible individuals) is stopped. ... The Winners curse is a phenomenon akin to a Pyrrhic victory that occurs in common value auctions with incomplete information. ...


Speculative purchasing can also create inflationary pressure, causing particular prices to increase above their "true value" (real value - adjusted for inflation) simply because the speculative purchasing artificially increases the demand. Speculative selling can also have the opposite effect, causing prices to artificially decrease below their "true value" in a similar fashion. In various situations price rises due to speculative purchasing cause further speculative purchasing in the hope that the price will continue to rise. This creates a positive feedback loop in which prices rise dramatically above the underlying "value" or "worth" of the items. This is known as an economic bubble. Such a period of increasing speculative purchasing is typically followed by one of speculative selling in which the price falls significantly, in extreme cases this may lead to crashes. Overall, the participation of speculators in financial markets tends to be accompanied by significant increase in short term market volatility. This is not necessarily a bad thing, as heightened level of volatility implies that the market will be able to correct perceived mis-pricings more rapidly and in a more drastic manner. Positive feedback is a feedback system in which the system responds to the perturbation in the same direction as the perturbation (It is sometimes referred to as cumulative causation). ... Currier & Ives print on economic bubbles, 1875. ... Black Monday (1987) on the Dow Jones Industrial Average A stock market crash is a sudden dramatic loss of value of shares of stock in corporations. ...


Books

  • Sobel, Robert (1973, reprinted 2000). The Money Manias: The Eras of Great Speculation in America, 1770-1970. Beard Books (2000). (ISBN 1587980282).
  • Gunther, Max (1992). The Zurich Axioms. Souvenir Press. (ISBN 0-285-63095-4).
  • Niederhoffer, Victor (2005). Practical Speculation. Wiley. (ISBN 0-471-67774-4).

See also

Look up speculation in Wiktionary, the free dictionary.

  Results from FactBites:
 
speculation: Definition, Synonyms and Much More from Answers.com (1764 words)
Speculation exists in many such commodities but, if measured by value, the most important markets deal in financial futures contracts and other derivatives which involve leverage that can transform a small market movement into a huge gain or loss.
The service provided by speculators to a market is primarily that by risking their own capital in the hope of profit, they add liquidity to the market and make it easier for others to offset risk, including those who may be classified as hedgers and arbitrageurs.
Such a period of increasing speculative purchasing is typically followed by one of speculative selling in which the price falls significantly, in extreme cases this may lead to crashes.
  More results at FactBites »

 
 

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