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1. Derivatives: options,
warrants.

2. Derivatives: options,
warrants.
 Derivatives
 Categorization of derivatives
 Uses of derivatives
 Types of derivatives
 Valuation
 Options
 Warrants

4. Derivatives
 A derivative is a financial instrument - or
more simply, an agreement between two
people or two parties - that has a value
determined by the price of something
else (called the underlying).[1] It is a
financial contract with a value linked to
the expected future price movements of
the asset it is linked to - such as a share
or a currency. There are many kinds of
derivatives, with the most notable being
swaps, futures, and options.
 Referring to derivatives as stand-alone
assets would be a misconception, since a
derivative is incapable of having value of
its own. However, some more
commonplace derivatives, such as
swaps, futures, and options, (which have
a theoretical face value that can be
calculated using formulas, such as Black-
Scholes), have been traded on markets
before their expiration date as if they
were assets. Amongst the earlier
derivatives, rice futures have been
traded on the Dojima Rice Exchange
since 1710

6. Uses of derivatives
 Derivatives are used by investors to
 provide leverage or gearing, such that a small movement
in the underlying value can cause a large difference in the
value of the derivative
 speculate and to make a profit if the value of the
underlying asset moves the way they expect (e.g., moves
in a given direction, stays in or out of a specified range,
reaches a certain level)
 hedge or mitigate risk in the underlying, by entering into a
derivative contract whose value moves in the opposite
direction to their underlying position and cancels part or
all of it out
 obtain exposure to underlying where it is not possible to
trade in the underlying (e.g., weather derivatives)
 create optionability where the value of the derivative is
linked to a specific condition or event (e.g., the underlying
reaching a specific price level)

8. Types of derivatives
 OTC and exchange-traded
 Over-the-counter (OTC) derivatives are contracts
that are traded (and privately negotiated) directly
between two parties, without going through an
exchange or other intermediary. Products such as
swaps, forward rate agreements, and exotic
options are almost always traded in this way. The
OTC derivative market is the largest market for
derivatives, and is largely unregulated with
respect to disclosure of information between the
parties, since the OTC market is made up of banks
and other highly sophisticated parties, such as
hedge funds. Reporting of OTC amounts are
difficult because trades can occur in private,
without activity being visible on any exchange.
 Exchange-traded derivative contracts (ETD) are
those derivatives instruments that are traded via
specialized derivatives exchanges or other
exchanges. A derivatives exchange is a market
where individuals trade standardized contracts
that have been defined by the exchange.[7] A
derivatives exchange acts as an intermediary to all
related transactions, and takes Initial margin from
both sides of the trade to act as a guarantee.

10. Types of derivatives
 Futures/Forwards are contracts to buy or sell an
asset on or before a future date at a price specified
today. A futures contract differs from a forward
contract in that the futures contract is a
standardized contract written by a clearing house
that operates an exchange where the contract can
be bought and sold, whereas a forward contract is a
non-standardized contract written by the parties
themselves.
 Options are contracts that give the owner the right,
but not the obligation, to buy (in the case of a call
option) or sell (in the case of a put option) an
asset.
 Swaps are contracts to exchange cash (flows) on or
before a specified future date based on the
underlying value of currencies/exchange rates,
bonds/interest rates, commodities, stocks or other
assets.

12. Valuation of derivatives
 Two common measures of value are:
 Determining the market price
For exchange-traded derivatives, market price is usually
transparent (often published in real time by the exchange, based on
all the current bids and offers placed on that particular contract at
any one time). Complications can arise with OTC or floor-traded
contracts though, as trading is handled manually, making it difficult
to automatically broadcast prices. In particular with OTC contracts,
there is no central exchange to collate and disseminate prices.
 Determining the arbitrage-free price
The arbitrage-free price for a derivatives contract is complex, and
there are many different variables to consider. Arbitrage-free
pricing is a central topic of financial mathematics. The stochastic
process of the price of the underlying asset is often crucial. A key
equation for the theoretical valuation of options is the Black–
Scholes formula, which is based on the assumption that the cash
flows from a European stock option can be replicated by a
continuous buying and selling strategy using only the stock. A
simplified version of this valuation technique is the binomial
options model.

14. Options
 In finance, an option is a derivative financial instrument that
establishes a contract between two parties concerning the buying
or selling of an asset at a reference price during a specified time
frame. During this time frame, the buyer of the option gains the
right, but not the obligation, to engage in some specific transaction
on the asset, while the seller incurs the obligation to fulfill the
transaction if so requested by the buyer. The price of an option
derives from the value of an underlying asset (commonly a stock, a
bond, a currency or a futures contract) plus a premium based on
the time remaining until the expiration of the option. Other types of
options exist, and options can in principle be created for any type of
valuable asset.
 An option which conveys the right to buy something is called a call; an option
which conveys the right to sell is called a put. The price specified at which
the underlying may be traded is called the strike price or exercise price. The
process of activating an option and thereby trading the underlying at the
agreed-upon price is referred to as exercising it. Most options have an
expiration date. If the option is not exercised by the expiration date, it
becomes void and worthless.
 In return for granting the option, called writing the option, the originator of
the option collects a payment, the premium, from the buyer. The writer of an
option must make good on delivering (or receiving) the underlying asset or
its cash equivalent, if the option is exercised.

16. Warrants
 In finance, a warrant is a security that entitles the holder to buy
stock of the issuing company at a specified price, which can be
higher or lower than the stock price at time of issue.
 Warrants and options are similar in that the two contractual financial
instruments allow the holder special rights to buy securities. Both
are discretionary and have expiration dates. The word warrant
simply means to "endow with the right", which is only slightly
different to the meaning of an option.
 Warrants are frequently attached to bonds or preferred stock as a
sweetener, allowing the issuer to pay lower interest rates or
dividends. They can be used to enhance the yield of the bond, and
make them more attractive to potential buyers. Warrants can also be
used in private equity deals. Frequently, these warrants are
detachable, and can be sold independently of the bond or stock.
 In the case of warrants issued with preferred stocks, stockholders
may need to detach and sell the warrant before they can receive
dividend payments. Thus, it is sometimes beneficial to detach and
sell a warrant as soon as possible so the investor can earn dividends.
 Warrants are actively traded in some financial markets such as
Deutsche Börse and Hong Kong.[1] In Hong Kong Stock Exchange,
warrants accounted for 11.7% of the turnover in the first quarter of
2009, just second to the callable bull/bear contract.

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