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Futures & Forwards Contract Derivtives In A Nutshell
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Futures & Forwards Contract Derivtives In A Nutshell

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    Futures & Forwards Contract Derivtives In A Nutshell Futures & Forwards Contract Derivtives In A Nutshell Presentation Transcript

    • Futures and Forwards contract Derivatives in a Nutshell By Shravan Bhumkar (KH08JUNMBA100) Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • What is a Derivative ?  Simply defined “a derivative is a price guarantee” .  Nearly every derivative out there is just “an agreement between future buyer and future seller specifying a future price at which some item can or must be sold this item is know as ‘underlier’ might be some physical commodity or some financial security”.  Every derivative also specifies a future date on or before which transaction must occur.  These are the common elements of all derivatives : 1. Buyer and seller, 2. Underlier, 3. Future price , 4.Future date. Buyer Seller physical commodity /financial security Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Types of Derivatives Forward contract Futures contract Derivatives Option contract Swap contract Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Forward contract A forward contract is an agreement to buy something at a specified price on specified future date. Spot Price Future Price Wheat farmer Today`s date Future date Duration of the contract Wheat Trader Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Forwards contract  Over the counter (OTC) product  Customized contract terms  Less liquid  No margin payment  Exposed to counter party risk  Settlement happens at end of contract Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Futures contract A futures contract is a standardized forward contract executed at an exchange, a forum that brings buyers and sellers together. At an exchange Wheat farmer The futures price moves exactly in tandem with Market price Daily settlement Wheat Trader Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Futures contract  Trade on an organized exchange  Standardized contract term  Daily Settlement, hence more liquid  Requires margin, counter party risk is minimum  The interests of buyer and seller are safe guarded to a great extent Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Common Terminologies Spot price : The price at which an asset trades in the spot market. Future price : The price at which the futures contract trades in the futures market. Contract cycle: The period over which contract trades. Expiry date: It is the date specified in the futures contract. This is last day on which the contract will be traded, at the end of which it will cease to exist. Contract size: The amount of asset that has to be delivered under one contract. Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Common Terminologies Basis : In the context of financial futures, basis can be defined as futures price minus the spot price. Cost of carry : This is the cost of maintaining or “carrying” a forward position over time. Initial margin : That the amount must be deposited in the margin account at the time a futures contract is first entered into is initial margin. Mark-to-market : In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor`s gain or loss depending upon the futures closing price. This is called mark to market. Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Distinction between Futures & Forwards Futures Market Forwards Market Location Future exchange No fixed location Size of contract Fixed (standard) Depends on terms of contract Maturity/Payment Fixed (standard) Depends on terms of date contract Counter party Clearing house Known bank or client Market place Central exchange floor Over the telephone with with worldwide network worldwide network/or anywhere Valuation Mark-to-market everyday No unique method of valuation Variation margins Daily None Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Distinction between Futures & Forwards Futures Market Forwards Market Credit risk Almost non existent Depends on the counterparty Settlement Through clearing house Depends on terms of contract Liquidation Mostly by offsetting the Mostly settled by actual positions; very few by delivery delivery. Some by cancelation at cost Transaction Direct costs such as commission, Direct costs are generally cost clearing charges, exchange fees low, indirect costs are high in are high; indirect costs, bid risk for of high bid risk spread spreads are low Regulations in Regulated by exchanges Self regulated trading concerned Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Commodities There are zillion commodities available in the world. But the commodities that become a good derivative underliers should be fungible (as good as another) and liquid (there are large number of active buyers and sellers). Theses commodities are classified into four major categories 1. Commodities A. Grains B. Metals 2. Foreign exchange 3. Interest rate 4. Equities Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • How derivatives are used ? Hedgers use derivatives to manage uncertainty. (Individuals, Partnership firms, Companies) Speculators use derivatives to wager on it. (Individuals, Partnership firms, Companies) Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • How derivatives are used ? Market-makers are the merchants Arbitrageurs avoid taking risks. of derivatives. (Individuals, Partnership firms, (Banks , Finance Houses) Companies) Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Conclusion Let the market be “bullish” or “bearish” if you know derivatives you will flourish. Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar
    • Thank you. Financial & Cost Accounting Batch- XIII (B) Prof. Hardic Mehta Shravan Bhumkar