Final answer:
Futures markets impact traders, investors, and financial institutions by favoring liquidity over minimizing basis risk, with liquidity offering quick and cost-efficient trading and basis risk affecting only those holding contracts till delivery.
Step-by-step explanation:
In class, we discuss that given a choice between liquidity and basis risk, futures markets chose institutional arrangements that favored liquidity. The individuals and entities impacted by this choice are traders, investors, and financial institutions operating within these markets. Two key reasons for prioritizing liquidity over minimizing basis risk are:
- Liquidity ensures that participants can quickly enter or exit positions without a significant loss in value, which is critical for traders who need to adapt rapidly to changes in the market or who are seeking to take advantage of short-term opportunities.
- Higher liquidity often leads to tighter bid-ask spreads, which reduces transaction costs for all market participants, thereby encouraging even more trading and liquidity. This positive feedback loop appears to be more beneficial for the market as a whole than focusing on minimizing basis risk, which affects only those who hold futures contracts until delivery.
Futures markets, therefore, impact everyone involved in them by favoring liquidity to facilitate trading and reduce transaction costs, which can lead to a more robust and efficient market.