Worried about a decline in the value of your home? Financial instruments are now available that can alleviate your fears, at least according to those who are offering these products. The indexing mania that now reaches virtually every corner of the capital markets recently extended into residential real estate, through the S&P/Case-Shiller Home Price indices, which cover 20 metropolitan areas, and include a nation-wide gauge as well. These market barometers have given rise to investment vehicles that have the potential to provide a hedge against declining home prices, or, alternatively, to allow speculators to bet on rising prices.
Though it is possible for home owners to participate in this market, we do not encourage anyone to rush out and embrace these products. These instruments were intended to appeal to builders, lenders, and other industry participants who have a large stake in the residential real estate market. We only cite this development to highlight the remarkable innovative capacity of U.S. capital markets. Enormous advances in information technology and data transmission now allow market participants to instantly gather, combine or segment, and ultimately bet on the aggregate prices of virtually any widely owned asset — the concept is not even restricted to assets; one can bet on or take refuge from the possibility of inclement weather through weather futures contracts.
One can participate in the residential real estate market through housing index futures contracts or through options on housing index futures. A futures contract is simply an agreement between a buyer and a seller to exchange an asset at a specified future date at a price set today. The seller is betting that prices will decline during the interim, while the buyer hopes for a rising price. Futures options, unlike futures contracts, provide a limited downside. An option provides its buyer with the right to exercise an option to buy (or to sell) an asset at a predetermined “strike” price for a limited period of time. If the asset price moves in an unfavorable direction, the buyer simply does not exercise the option, and it expires worthless, but the investor’s loss is limited to the price he paid for it.
Individual investors, however, need not be familiar with the intricacies of these instruments to benefit from them. Economic growth ultimately benefits all of us, but growth requires capital investment and risk-taking. The ever-improving ability of market participants to gauge and refine their risk exposure bodes well for the supply of investment capital and for our future.
Also in This Issue:
REITs: Up, Up, and Away
Kentucky Court Case Could Bring Major Changes for Municipal Bond Market
AIS Adds Fidelity Investments as Custodian
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
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