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Markets

Chicago Merc: Exchange Megamerger

What's in the future for the Chicago Mercantile Exchange and the Chicago Board of Trade?

Traders have been betting and hedging on the future from the floors of the Chicago Mercantile Exchange and the Chicago Board of Trade since the nineteenth century. And now, the Windy City rivals are betting on a future together. On October 17, the two publicly traded exchanges announced plans to combine.

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Both the Merc and the CBOT are exchanges for trading risk using financial instruments. People who want to avoid risk (hedgers) seek to guarantee some return on everything from soybeans to stock market returns to interest rates. People who figure they can profit from the risk (speculators) trade the instruments, betting on whether prices will rise or fall. The exchanges profit by getting a cut from every transaction. The riskier the financial world gets, the more money they make.

In a world where such exchanges are consolidating, the merger "makes complete strategic sense," says Raymond James analyst Michael Vinciquerra. The combined Merc and CBOT would create the world's largest derivatives exchange, which would also be the dominant exchange in the key area of interest rate products. And the merger would make two profitable companies even more so by allowing them to save on operations costs.

Screaming traders may dominate images of the exchanges, but the tapping of computer keyboards is now the only noise most transactions generate. The transition from traditional floor trading to electronic trading is a boon to volume and profits. Today, about 70% of the Merc's trades are electronic.

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The explosion of futures, options and derivatives that the exchanges deal in is reflected in the Merc's success. Profits have leapt from $3.60 per share in 2003 to an estimated $11.44 this year. Since its initial public offering in late 2002, the stock has soared twelvefold, to $507 as of the October 18 close.

CBOT is no slacker, either. Its revenues for the quarter ending September 30 increased 45%, to $163 million, year over year. Net income more than doubled, to $48.8 million.

The Merc will pay approximately $8 billion for its smaller rival.

The exchanges are all about the future, so it's no surprise that the market had already raised the price of both exchanges' stocks, figuring on increased prosperity from a merger. The Merc (symbol CME) trades at 35 times next year's earnings per share, and CBOT (BOT), 38 times. Many analysts, including Vinciquerra, don't think smart speculators would bet on big gains for the companies' stocks at this point. And predicting the future successfully is the name of the game, after all.

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