Introduction Derivatives Market is bigger than stock Market. It comes from Securitization. It shifts Risk within participants. It is too risky and high leveraged . It Reduces transaction cost. It provides price information. Great deal of liquidity Attract different types of dealers
Exchange trade and OTC Option and Future Contracts @Standardizedexchange trade backed by clearinghouse. (CME,CBOE ) Forward, Swaps and Bond Option @ UnregulatedOTC / Dealer Market has no central location withhigh credit risk. Bigger than Exchange-trade witheasier term of contract and free negotiation. Electronic trading, Robo, Black box,automated, high frequency
Contract Commitment Vs. Contingent Claim Forward Contract: Spot Contract is alegally promise to perform an action infuture. Same as Forward, future, swap, Contingent Claim for broken certainthreshold. Same as Option Two options replicate a forward or futurecontract. Long position payoff: ST-K Short position payoff: K-ST
Types of Participant andtrader Participants:1. Buyer of call2. Seller of call3. Buyer of put4. Seller of put Trader:1. Hedger2. Speculator3. Arbitrageur
Arbitrage Two identical payoff have the same price. Certain pay off of a portfolio is more than riskfree rate. Market Efficiency. Mispricing asset bring up arbitrage opportunity. Combining uncertain returns in portfolio to resultcertain return.
HedgerReducing Risk with no guarantee of better off.Always avoid of exposure to risk. Using Forward ContractLocking the exchange rate in forward contract. ItNeutralizes by Fixing the price. Using OptionStock option is used to protect losing on stock priceand provide insurance.Upfront fees is needed
SpeculatorLooking for a position of exposure. Using FutureIn hope of strength of currency:1. Purchase currency in spot market.(need highinvestment)2. take long position in future contract on currency. Using optionIn hope of stock price growth:1.Purchse stock2.Long position in call option (more profitable)
Arbitrageur Locking in riskless profit in two or more Market Caused by discrepancy of price in two markets Last very short as Market get balance by demandand supply and transaction costs.