More Related Content


Class 1.pdf

  1. knowledge skills technology innoventures
  2. 2 2 Session 1 Risk Management  Topics to be covered in this session:  Futures and Forwards I
  3. 3 3 Session Learning Objectives… At the end of this session you should be able to :  Explain the concept of derivatives  Explain the forwards and futures contract  State the concept of Hedge funds
  4. 4 4 Derivatives  Derivatives are instruments whose value is derived from the value of one or more underlying assets  E.g.: Futures, forwards, swaps, options etc.  The Underlying Assets can be:  Stocks, currencies, interest rates, commodities, credit risk of cash flows, etc.
  5. 5 5 Trading Of Derivatives  Exchanges such as the CBOE, NYMEX, NSE, BSE, MCX, NCDEX  Over-the-counter (OTC) market where traders working for banks, fund managers and corporate treasurers contact each other directly
  6. 6 6 Uses of Derivatives  To hedge the risks  To speculate  To lock in an arbitrage profit  To change the nature of a liability
  7. 7 7  Lehman Brothers filed for bankruptcy on September 15, 2008 - the biggest bankruptcy in US history  It was an active participant in the OTC derivatives markets  It got into financial difficulties as it took high risks and found that it was unable to meet its short term funding  It had a large amount of transactions outstanding with about 8,000 counterparties  Unwinding these transactions became very difficult for both the Lehman liquidators and their counterparties Lehman Brothers -Case
  8. 8 8 An amount of $2,440.00 is deposited in a bank paying an annual interest rate of 3.4%, compounded continuously. Find the balance after 2 years Continuous Compounding
  9. 9 9 Solution: Continuous compound interest: A = Pert, Where, P = 2440, r = 3.4/100 = 0.034, t = 2, e = 2.7183 (approximately) The balance after 2 years is approximately $2611.69 Continuous Compounding
  10. 10 10  Hedge funds cannot offer their securities publicly and are not subject to the same rules as mutual funds.  Mutual funds must  Disclose investment policies  Makes shares redeemable at any time  Limit use of leverage  Take no short positions Hedge Funds
  11. 11 11  Hedge funds are not subject to the constraints mentioned previously for the mutual funds  Hedge funds use complex trading strategies Hedge Funds
  12. 12 12  It is a customized agreement to buy or sell an asset at today’s determined price which will be settled at a certain time in future  These are traded in the over-the-counter market mostly between two financial institutions or between a financial institution and a client  One of them holds a long position and the other holds a short position Forward Contracts
  13. 13 13  Forward contracts can be used to hedge foreign currency risk  Mostly large banks have both:  Spot traders : They trade in foreign currency for almost immediate delivery  Forward traders: they trade for delivery at a future time Forward Contracts
  14. 14 14  It is an agreement between two parties to buy or sell an asset for a certain price at a certain time in future  They are normally traded on the exchanges  A wide rage of commodities and financial assets form the underlying assets in the various contracts  Some of the commodities are pork bellies, live cattle, sugar, wool, lumber, cooper, aluminum, gold and tin  Some of the financial assets include stock indices, currencies, and treasury bonds Futures Contracts
  15. 15 15 Futures & Forwards Contracts Comparison FUTURES CONTRACT FORWARD CONTRACT Traded on Organized exchanges Traded OTC Standardized contracts, more liquid Customized Contracts, less liquid Requires margin payment No margin payment required Follows daily settlement No daily settlement No counterparty risk Counterparty risk exists Final settlement: By delivery of underlying asset or cash settled Final settlement: Settled by delivery Exit prior to maturity: by offsetting the initial position Exit prior to maturity: not possible unless both parties agree
  16. 16 16 Before We End… Summing up what we have learned and are now able to do:  Explain the concept of derivatives  Explain the forwards and futures contract  State the concept of Hedge funds
  17. 17 17 Crib Sheet Derivative A derivative is a security whose value is derived from the value of the underlying asset. Example of such an instrument includes future, forward etc and the underlying assets are stocks, currencies etc. Uses of derivatives Derivatives have evolved as an instrument for hedging the risk associated in buying, holding, and selling of various kinds of financial assets. This instrument is also used to speculate, lock in an arbitrage profit, and change the nature of a liability. Hedge fund A hedge fund is constructed with a pool of invested money administered by a fund manager with an object maximising returns and elimination of risk. Unlike a mutual fund, the hedge fund cannot offer their securities publicly.
  18. 18 18 Crib Sheet Forward contract A forward contract may be described as an agreement to buy or sell an asset at a predetermined price and at a specified future time. These are traded in the over-the- counter market. One of the participants may hold a long position and the other may hold a short position. Future contract: This kind of instrument is used for managing or hedging the risk in commodity and financial market due to price fluctuations in the market. The nature of futures is similar to forward contract however, in terms of features and modalities of operation they are vastly different from each other. This instrument is normally traded on the exchange.
  19. THANK YOU… All information, including graphical representations, etc provided in this presentation is for exclusive use of current GBS students and faculty. No part of the document may be reproduced in any form or by any means, electronic or otherwise, without written permission of the owner.