Essays on Corporate Finance Assignment

Download full paperFile format: .doc, available for editing

Question 1:   ii) What are the advantages and disadvantages of CFDs for a small (retail) investor compared to individual share futures contracts or Low exercise price options (LEPOs)   Both CFDs and futures contracts have advantages and disadvantages for small investors. Firstly, CFD trading is a model for small investors, as they do not necessarily need to outlay huge capital in order to get a potentially big return. Basically, an investor is only required to expend a fraction of capital required to directly invest in commodities or shares (Siganos 2010).   Thirdly, CFD has a lower margin requirements, access to the global market is eased, no shorting or any day trading rules, as well as little or no fees for professional execution.

All the benefits favor small investor investors who may not be tremendously funded. Trading with CFDs is better in the sense that dealing with a specific trader makes the dealing systematic, and hence a better model for small investors. In contrast, single stock futures contain an expiry date. There pricing, therefore, constitutes a forward premium of interest as well as a discounted dividend that can be confusing, hence not very convenient for small investors.     On the other hand, CFDs can be disadvantageous to retail investors.

Unlike futures that are transferable and standardized instruments, CFDs at times can be over the counter. The choice of the broker becomes an issue for investors, especially to retail ones. The potential to profit well in small moves is eliminated (Siganos 2010). Also, the CFD industry is lowly regulated. The credibility of the broker is mainly based on the financial position, reputation, and life span.   Due to limited means and resources to investigate eligibility, small investors may be at risk of losing funds to fraud brokers.

Moreover, the high leverage magnifies losses when a huge price movement fails to take place.   These risks arise when the issuer fails to meet their required obligations to the investor (ASIC 2010).   iii) What are the differences and similarities between Futures Contracts and LEPOs? Futures contracts constitute a contractual agreement to buy or sell a specific financial instrument or the commodity in the future at a pre-determined price. This agreement is mainly prepared on the trading bases of futures exchange futures contracts that can necessitate the physical delivery of the asset, and others may be settled in cash (Tanlapco et al.

2002). Low exercise price options (LEPOs) are call options that have a one-cent exercise price, and an agreement of purchase of 1 cent, purchasing 100 shares. Until expiry, they are not be exercised. The paid premium is mainly the price that purchases the entire share, though the only percentage as the margin is posted by the purchaser (ASX 2011). Another major difference between LEPOs and futures contract is that the holder of options has a right sell or buys the basic asset at expiration, while futures contract holder is required to execute the terms of the contract.

The primary similarity between LEPOs and futures contract is that both have an expiry date (McGill & Winston 2008).       iv) Some CFDs are exchange-traded whereas others are traded over the counter. What are the advantages and disadvantages of exchange-traded CFDs vs over the counter CFDs Exchange-traded CFDs have various disadvantages. To begin with, CFD traders may deal with the fact that only a restricted range of CFDs may be available on the place of exchange.

That is, unlike in over the counter CFDs, traders with exchange-traded CFDs, securities that a trader deals with may simply not available. Secondly, there are numerous costs linked to exchange-traded CFDs.

References

Brealey, A., Myers, C., & Allen, F., 2006, Corporate finance (Vol. 8), Boston et al.: McGraw-Hill/Irwin.

Brown, C., Dark, J., & Davis, K 2010, Exchange traded contracts for difference: Design, pricing, and effects. Journal of Futures Markets, 30(12), 1108-1149.

Higham, D., 2004, An introduction to financial option valuation: mathematics, stochastics and computation (Vol. 13), Cambridge University Press.Hull, J., Hull, J., Hull, J., & Hull, J., 2008, Fundamentals of futures and options markets, Pearson Prentice Hall

Kristiansen, T 2004, Pricing of Contracts for Difference in the Nordic market. Energy Policy, 32(9), 1075-1085.

McGill, B. J., & Winston, E. J 2008, U.S. Patent No. 7,409,367. Washington, DC: U.S. Patent and Trademark Office.

Siganos, A 2010, Can small investors exploit the momentum effect?. Financial Markets and Portfolio Management, 24(2), 171-192.

Tanlapco, E., Lawarrée, J., & Liu, C. C 2002, Hedging with futures contracts in a deregulated electricity industry. Power Systems, IEEE Transactions on, 17(3), 577-582.

Download full paperFile format: .doc, available for editing
Contact Us