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The New Chemistry of Speculation, Case Study Example

Pages: 2

Words: 480

Case Study
  1. In May, the Credit Suisse Group and the Deutsche Bank began offering investments in iron ore, which is a key component to being able to make steel.
  2. Lawmakers are very justified in their claims that speculation is driving up the costs of commodity prices in areas such as iron ore, alumina, cobalt, molybdenum, ferrochrome and vanadium.  The reason why they are justified is because speculation is a process where investors are continually being told that the prices will increase as well as the overall value on the commodity.  As investors continue to purchase these goods at higher prices, they are also expecting that their value will increase to sell them at a higher price than what they paid for, essentially making a large profit.  The same tactics are done in the real estate business with practices such as flipping houses and other real estate investment techniques.  In other words, the commodity itself has no control or no value, it is the value that the people desire the product that makes the difference.
  3. The process that Credit Suisse works the monthly settlements is actually very interesting.  The contracts as known as “cash-settled swaps,” where the client agrees to pay a fixed price on the iron ore, or the commodity, in the future.  The client can be anyone or anything such as a hedge fund, pension fund or a steelmaker.  The current future fixed price is set at $180 per metric ton.  The bank, then, lines up a seller that wants to lock in that price and Credit Suisse forces a minimum transaction of 5,000 metric tons.  That is a total of $900,000 for a minimum transaction of iron ore.  Instead of any physical deliver, a net payment in cash is made each month that totals the cost of the difference between the set price and a floating price.  The floating price is set to an index of the spot price that steelmakers pay for iron ore that can be delivered immediately.  This way the bank makes a larger profit, while the investor never actually has the raw materials.
  4. The monthly contracts do make it more attractive to buyers and investors because they are not fixed in at any particular price for longer than one month at a time.  If the spot price should rise too far or if speculation does not show the benefits that it should, the buyer can get out of the contract after the monthly contract expires.  Again, the same process works in flipping housing for real estate.  A person can agree to purchase a house, but has 30 days to find a person that will buy it for more than the agreed upon selling price.  If the 30 days ends and no future buyer is found, the original buyer is not obligated the purchase the home and is not out any money.  This is a very common practice among investors.
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