What Is the Cash Market and How Does it Differ from Derivatives Markets?
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The cash market and the derivatives market are two fundamental pillars of the financial system, each serving distinct purposes in facilitating asset trading. While both markets deal with buying and selling assets, they differ significantly in terms of transaction timelines, asset ownership, and risk profiles.
What is the Cash Market?
The cash market, also known as the spot market, is a marketplace where the immediate buying and selling of financial instruments occur. Transactions in the cash market are settled promptly, typically within two to three business days after the trade is executed. This means that upon purchase, ownership of the underlying asset is transferred from the seller to the buyer.Here are some key characteristics of the cash market:- Immediate Delivery: Transactions are settled promptly, with ownership transferred upon delivery.
- Physical Assets: The cash market primarily deals with physical assets such as stocks, bonds, commodities, and currencies.
- Ownership Transfer: Ownership of the underlying asset is transferred from the seller to the buyer.
- Dividends and Interest: Investors in the cash market are entitled to receive dividends or interest payments associated with the underlying asset.
What is a Derivatives Market?
In contrast to the cash market, the derivatives market deals with contracts that derive their value from an underlying asset, such as a stock, bond, commodity, or currency. These contracts, known as derivatives, obligate the parties involved to buy or sell the underlying asset at a predetermined price on a specific future date.Here are some key distinguishing features of the derivatives market:- Contract-Based Trading: Derivatives markets trade contracts like futures and options, not the underlying assets themselves.
- Speculation and Hedging: Derivatives are often used for speculation on future price movements or hedging existing holdings against potential price fluctuations.
- Margin Trading: Derivatives trading often involves margin requirements, where only a portion of the contract value needs to be deposited upfront.
- Expiration Date: Derivatives contracts have a specified expiration date on which the terms of the contract must be fulfilled.
Key Differences Between Cash and Derivatives Markets
While both cash and derivatives markets play essential roles in the financial system, they cater to distinct needs and objectives. Here's a table summarising the key differences between the two:| Feature | Cash Market | Derivatives Market |
| Meaning | Immediate trading of assets | Trading of contracts based on underlying assets |
| Ownership Transfer | Ownership transferred upon delivery | Ownership not transferred |
| Lot Sizes | Allows trading of single units | Set lot sizes, no single-unit trades |
| Dividends/Interest | Investors receive dividends/interest | Investors do not receive dividends/interest |
| Trading Mode | Requires trading and Demat account | Requires futures trading account |
| Nature of Assets | Deals primarily in physical assets | Can trade both tangible and intangible assets |
| Duration | Provides lifetime ownership | Transactions have an expiration date |
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