1. Tell me about DERIVATIVES
Volume -1
(Dude, keep it really simple !!)
Disclaimers:
Do not enter into contracts or agreements
based on the information contained in this
presentation
Taking any action or placing any reliance
on the contents of this presentation is
strictly prohibited
Any views or opinions expressed or stated
in this presentation are solely those of the
author and do not represent those of the
author’s employers either past or present
The author accepts NO liability for any
damage caused by any information
contained in this presentation
Disclosing, copying or distributing this
information in whole or in part is strictly
prohibited
Sources are acknowledged

2. Derivative ?
It’s a financial contract that
derives value from something
else (i.e. the underlying value)
Such value can be derived from
stocks, bonds, commodities,
exchange rates, interest rates
etc.

3. Common derivatives ?
Forwards Options
Commodities long Call option or Put option
forward contract or short
forward contract
Types
Swaps
e.g. interest rate swaps,
currency swaps, credit default
swaps, etc.

4. Forward contract ?
When 2 parties agree to buy or sell an
asset at some point specified in the future

5. Options ?
Call option = Owner has the
right but not the obligation to
buy
Put option = Owner has the
right but not the obligation to
sell
When the owner exercises
this right the other party (i.e.
counterparty) is obligated to
perform transaction

6. Swaps ?
Contracts to exchange cash-flows on or
before a specified future date based on
the underlying value of the instrument
The counterparties (i.e. parties to the
contract) usually do not exchange the
principal amount
Cash-flows are computed based on
notional principal amounts

7. Objective of derivatives ?
Hedging = mitigate the risk of
exposure due to economic loss
arising from changes in the
underlying value
Speculation = to profit from
fluctuations in the underlying
value

8. Example 1: exchange of a fixed
rate loan to a floating rate loan
(same currency)
$5M @ 5.25% p.a.
$5M @ 5.25% p.a.
Party
Party payable monthly (fixed)
payable monthly (fixed)
A
A
Party A locks in
Party A locks in
.25% or 25 bp
.25% or 25 bp
profit. Net movement
profit. Net movement
in cash-flows.
in cash-flows.
$5M @ Libor + 25 basis
$5M @ Libor + 25 basis
Party points (say 5%) payable
Party points (say 5%) payable
B monthly (floating)
B monthly (floating)

9. Example 2: call option for
stocks
Party-A buys Party-B sell stocks Party-A is hopeful
1000 stocks at a strike price that the stocks
from Party-B of $5 / option for a would gain value in
premium of $1 each the future
1 2 3
Party-A has the At a later point
Party-A contracts
right to buy but in time (usually pre
to sell stocks to
not the obligation. defined) the stocks
Party-C @ $8 each
Pays Party-B $1000 are worth $8 each
4 5 6
Party-C pays
Party-A exercises
Party-A pays Party-A $8000.
its right to buy
Party-B $5000 Party-A makes
stocks from
(1000 x $5) a profit of $2000
Party-C (8000-5000-1000)
7 8 9

10. Example 3: forward contract
payoff
David owns David knows
house worth the bank pays
$500K today interest 5% p.a.
Susan contracts
Susan pays $530K
with David to buy
at the end of one
house for $530K
year
in one year
Susan makes a profit of $20K.
Susan sold the house
Its unlikely David would have sold
in the market @ $550K
less than $525K (based on bank interest)

11. Source / Acknowledgement

12. Disclaimers
Do not enter into contracts or agreements based on the
information contained in this presentation
Taking any action or placing any reliance on the contents of
this presentation is strictly prohibited
Any views or opinions expressed or stated in this presentation
are solely those of the author and do not represent those of
the author’s employers either past or present
The author accepts NO liability for any damage caused by any
information contained in this presentation
Disclosing, copying or distributing this information in whole or
in part is strictly prohibited
Sources are acknowledged