Chicago Mercantile Exchange Essay

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The Chicago Mercantile Exchange (CME) is an American financial trading place based in Chicago. Often called MERC, it was founded in 1898 as the Chicago Butter and Egg Board. When the CME began it was a not-for-profit organization. Its purpose was to trade futures contracts on agricultural products. In 1919 it became the Chicago Mercantile Exchange.

In 1987 the CME began use of its Globex trading system. It then began operating an electronic trading system in futures contracts in 1992. By 2004 the system recorded its one billionth trade through the Globex system, which is a modified version of the NSC system developed in Europe for European exchanges. In 2006 the CME improved its ability to electronically trade in interest rate swaps with the purchase of Swapstream, a London based company. Electronic trading entered the CME’s electronic system on January 13, 2008. Several months prior to this CME was engaged in developing a commodities futures platform with the Singapore Exchange.

A major step in modernizing the corporate organization of the CME occurred in November 2000 when the CME was demutualized and became a joint stock company owned by shareholders. The CME’s demutualization was the first time in American financial history that an exchange had demutualized. In December 2002 it went public. In July of 2007 it completed its merger with the Chicago Board of Trade (CBOT) to become the CME Group through an exchange of $8 billion in stock. On August 18, 2008, CME’s shareholders approved a purchase of the New York Mercantile Exchange (NYMEX) for $8.9 billion in cash and CME stock. The CME and NYMEX systems are to be fully integrated by October 1, 2009. With the NYMEX’s trade in energy products, metals, and other commodities, the CME’s range of commodities and volume will increase dramatically.

The system of trading developed and used by the CME since its beginning was the open outcry system of trading. The system uses humans to stand and cry out bids to buy or sell. It appears chaotic but allows hundreds of auctions to be conducted simultaneously throughout the trading day. The New York Mercantile Exchange, the Chicago Board of Trade, and exchanges in other countries use a similar system.

The outcry system of trading places traders in a trading pit from which they cry out prices and quantities. These are interpreted by other trades as offers to buy or sell specific quantities of the commodity offered. Because the price is “discovered” through the outcry of traders it provides an efficient way to exchange contracts for commodities for future delivery or for speculation. Because of the din created by many traders shouting out orders to buy or sell, a system of complex hand signals called arb, short for arbitrage, is used.

The open outcry trading floor system of the CME is linked to the electronic trading platform called the “Globe.” It allows those who have signed up to trade to do so electronically from anywhere on the globe. The open outcry system is being replaced by the electronic systems because they are cheaper, faster, and can handle larger volumes. They are also not as vulnerable to manipulation of the market by traders, brokers, or dealers who are making a market. Defenders of the open outcry system argue that personal contact allows traders to read the intentions of others in the market and to make position adjustments accordingly. Currently 70 percent of the CME’s trade is through its electronic Globe system.

The CME has the world’s second largest futures exchange, and the largest in the United States. It provides a marketplace for trading futures and options on futures. Trade on the CME is in equities, stock indexes, foreign exchange currencies, commodities, and interest rates. It also provides a marketplace for trading in weather and in real estate derivatives. The financial instruments that it uses are either cash or primary instruments (loans, deposits, or securities) or derivatives. The derivatives can be traded through the exchange market or through the over-the-counter (OTC) market. Derivatives are financial instruments that derive their market price from an underlying financial instrument. Stock options are derivatives as are interest rate swaps.

On October 7, 2008, the CME partnered with the Citadel Investment Group to create an electronic trading platform (a trading floor) for trading credit default swaps (CDS). The CDS trading will allow banks and others to spread the risk of default by governments, companies or consumers. The move is expected to provide liquidity in the market for standardized contracts and future derivative markets. The Clearing Corporation will provide clearinghouse services with the Depository Trust and Clearing Corporation providing management of assets.

Bibliography:

  1. David Griesing and Laurie Morse, Brokers, Bagmen, and Moles: Fraud and Corruption in the Chicago Futures Markets (John Wiley & Sons, 1991);
  2. Joseph Leininger, Lessons from the Pit: A Successful Veteran of the Chicago Mercantile Exchange Shows Executives How to Thrive in a Competitive Environment (B&H Publishing, 1999);
  3. Jeffrey L. Rodengen, Past, Present and Futures: Chicago Mercantile Exchange (Write Stuff Enterprises, Inc., 2008);
  4. Robert A. Tamarkin, MERC: The Emergence of a Global Financial Powerhouse (Harper Business, 1993).

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