This document provides an introduction and overview of financial derivatives. It discusses the key types of derivatives like forwards, futures, and options. It defines derivatives as financial instruments whose value is based on an underlying asset. Forwards are customized over-the-counter contracts while futures are exchange-traded with standardized terms. Options provide the right but not obligation to buy or sell the underlying asset. The document also covers hedging strategies using derivatives and the factors that affect option pricing.
The document provides an overview of derivatives presented by group "The Trio" comprising of Neelam, Fatima, and Benish. It discusses the history and development of derivatives markets dating back to medieval times. It describes the key players in derivatives markets as hedgers, speculators, and arbitrageurs. Hedgers use derivatives to reduce risk, while speculators aim to profit from price movements. Arbitrageurs exploit temporary price differences across markets. The document also covers various types of derivatives including forwards, futures, and options contracts. It provides details on how these contracts work, their risk-return characteristics, and the current status of derivatives markets in Pakistan.
Derivatives - Basics of Derivatives contract covered in this pptSundar B N
Derivatives - Basics of Derivatives including forward, futures, swap and options contracts which covers HISTORY OF DERIVATIVES, CHARACTERISTICS OF DERIVATIVES , FEATURES OF DERIVATIVES, FUNCTIONS OF DERIVATIVES MARKET, USES OF DERIVATIVES, DIFFERENCE BETWEEN SHARES AND DERIVATIVES SHARES DERIVATIVES, DEFINITION OF UNDERLYING ASSET, DERIVATIVES ADVANTAGES AND DISADVANTAGES, PARTICIPANTS/ TRADERS IN DERIVATIVES MARKET, SPECULATORS, ARBITRAGEURS, HEDGER
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The document discusses the derivative market in India and risk management in banks. It defines derivatives and their various types like futures, options, and swaps. It explains how derivatives help banks manage risks like credit risk, interest rate risk, and liquidity risk. The history of derivatives trading in India is also summarized dating back to 1875. Key players in the market like hedgers, speculators, and arbitrageurs are identified along with their roles.
Derivatives are financial instruments whose value is dependent on an underlying asset. The three main types of derivatives are forwards, futures, and options. Forwards and futures are contracts to buy or sell an asset at a future date at a predetermined price, while options provide the right but not obligation to buy or sell an asset at a strike price. Derivatives allow traders to hedge risk, reduce transaction costs, manage portfolios, and enhance liquidity in markets.
This document provides an overview of derivatives markets, including forwards, futures, and options contracts. It defines each contract type and explains how they work. Forwards involve a private agreement between two parties to buy or sell an asset at a future date at an agreed upon price. Futures are standardized forward contracts that are traded on an exchange. Options provide the right, but not obligation, to buy or sell the underlying asset. The document discusses participants in these markets including hedgers who aim to reduce risk, speculators who take bets on price movements, and arbitrageurs who exploit temporary price differences. It also provides illustrations of how these contracts can be used for hedging or trading purposes.
Descriptions and explanation of all types of derivative instruments to trade with on the capital market.
http://www.koffeefinancial.com/Static/Learn.aspx
The document discusses various types of financial derivatives including futures, forwards, options, and swaps. It explains that derivatives derive their value from underlying assets and are used to hedge risk or profit from price changes. Futures contracts are exchange-traded standardized agreements to buy or sell assets at a future date, while other derivatives like forwards and swaps are customized over-the-counter transactions.
The document provides an overview of derivatives presented by group "The Trio" comprising of Neelam, Fatima, and Benish. It discusses the history and development of derivatives markets dating back to medieval times. It describes the key players in derivatives markets as hedgers, speculators, and arbitrageurs. Hedgers use derivatives to reduce risk, while speculators aim to profit from price movements. Arbitrageurs exploit temporary price differences across markets. The document also covers various types of derivatives including forwards, futures, and options contracts. It provides details on how these contracts work, their risk-return characteristics, and the current status of derivatives markets in Pakistan.
Derivatives - Basics of Derivatives contract covered in this pptSundar B N
Derivatives - Basics of Derivatives including forward, futures, swap and options contracts which covers HISTORY OF DERIVATIVES, CHARACTERISTICS OF DERIVATIVES , FEATURES OF DERIVATIVES, FUNCTIONS OF DERIVATIVES MARKET, USES OF DERIVATIVES, DIFFERENCE BETWEEN SHARES AND DERIVATIVES SHARES DERIVATIVES, DEFINITION OF UNDERLYING ASSET, DERIVATIVES ADVANTAGES AND DISADVANTAGES, PARTICIPANTS/ TRADERS IN DERIVATIVES MARKET, SPECULATORS, ARBITRAGEURS, HEDGER
Subscribe to Vision Academy for Video assistance
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The document discusses the derivative market in India and risk management in banks. It defines derivatives and their various types like futures, options, and swaps. It explains how derivatives help banks manage risks like credit risk, interest rate risk, and liquidity risk. The history of derivatives trading in India is also summarized dating back to 1875. Key players in the market like hedgers, speculators, and arbitrageurs are identified along with their roles.
Derivatives are financial instruments whose value is dependent on an underlying asset. The three main types of derivatives are forwards, futures, and options. Forwards and futures are contracts to buy or sell an asset at a future date at a predetermined price, while options provide the right but not obligation to buy or sell an asset at a strike price. Derivatives allow traders to hedge risk, reduce transaction costs, manage portfolios, and enhance liquidity in markets.
This document provides an overview of derivatives markets, including forwards, futures, and options contracts. It defines each contract type and explains how they work. Forwards involve a private agreement between two parties to buy or sell an asset at a future date at an agreed upon price. Futures are standardized forward contracts that are traded on an exchange. Options provide the right, but not obligation, to buy or sell the underlying asset. The document discusses participants in these markets including hedgers who aim to reduce risk, speculators who take bets on price movements, and arbitrageurs who exploit temporary price differences. It also provides illustrations of how these contracts can be used for hedging or trading purposes.
Descriptions and explanation of all types of derivative instruments to trade with on the capital market.
http://www.koffeefinancial.com/Static/Learn.aspx
The document discusses various types of financial derivatives including futures, forwards, options, and swaps. It explains that derivatives derive their value from underlying assets and are used to hedge risk or profit from price changes. Futures contracts are exchange-traded standardized agreements to buy or sell assets at a future date, while other derivatives like forwards and swaps are customized over-the-counter transactions.
This document defines various derivatives instruments and concepts. It begins by explaining that derivatives derive their value from an underlying asset and include futures, forwards, and options. It then discusses the different types of traders in derivatives markets including hedgers, speculators, and arbitrageurs. The document also compares over-the-counter (OTC) derivatives to exchange-traded derivatives and outlines some of the economic benefits of using derivatives. It provides examples and definitions for specific derivative types like forwards, futures, and options.
This document provides an introduction to options, including the different types (calls and puts), how they work, key terminology, and factors that influence pricing. An option gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before expiration. The buyer pays a premium to the seller for this right. Key terms discussed include strike price, expiration date, and long/short positions. Factors like time to expiration, volatility, and interest rates impact an option's price. The Black-Scholes model is commonly used to price options based on these variables.
Derivatives are financial instruments whose value is derived from an underlying asset. Forward and futures contracts are types of derivatives that allow parties to lock in a price today to purchase or sell an asset in the future. A forward contract is a customized over-the-counter agreement between two parties, while a futures contract is traded on an exchange with standardized terms. Both require mark-to-market adjustments and margin payments to mitigate risks from price fluctuations until contract settlement.
The document discusses the differences between stock markets and share markets, which essentially mean the same thing. It describes stocks as units of ownership in a company that can be traded, while shares are certificates of ownership issued by companies to raise funds. The stock market is an organized market for trading stocks and shares of government bodies and corporations. It also defines primary and secondary markets, as well as different types of stocks and indexes used in Indian stock markets like the BSE and NSE.
Options are a type of derivative security. They are a derivative because the price of an option is intrinsically linked to the price of something else. Specifically, options are contracts that grant the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date. The right to buy is called a call option and the right to sell is a put option. People somewhat familiar with derivatives may not see an obvious difference between this definition and what a future or forward contract does. The answer is that futures or forwards confer both the right and obligation to buy or sell at some point in the future. For example, somebody short a futures contract for cattle is obliged to deliver physical cows to a buyer unless they close out their positions before expiration. An options contract does not carry the same obligation, which is precisely why it is called an “option.”
Derivatives are financial instruments whose value is derived from an underlying asset such as a commodity, currency, bond, or stock. There are several types of derivatives including forwards, futures, and options. A forward is a customized contract where the buyer agrees to purchase an asset at a set price on a future date. Futures are standardized forward contracts that are exchange-traded. Options provide the right but not the obligation to buy or sell the underlying asset at a predetermined price on or before the expiration date.
This document summarizes different types of swap contracts. It begins with an overview of interest rate swaps, including how they allow entities to exchange fixed and variable rate financing. It then describes currency swaps, commodity swaps, credit default swaps, and equity swaps. For each type, it provides a definition and example to illustrate how the swap works. The presentation was given by Paulo Martins and Vilma Jordão to explain the role of swap contracts and how they can help companies manage financial risks.
The document defines options and futures contracts. It provides examples of different types of option contracts and discusses the key characteristics of options, including call and put options. It defines call options as giving the buyer the right to purchase an underlying asset and put options as giving the right to sell. It also discusses in-the-money, at-the-money, and out-of-the-money options based on the exercise price compared to the market price. The document then defines futures contracts and lists types of commodity and financial futures. It concludes by explaining the primary difference between options and futures - that options provide the right but not obligation to buy/sell the underlying asset, while futures contracts obligate the holder to fulfill the contract terms
This document provides an overview of financial derivatives, including:
- A derivative is a financial instrument whose value is derived from an underlying asset. Common types of derivatives include forwards, futures, options, and swaps.
- Derivatives can be traded over-the-counter (OTC) between two parties or on an exchange.
- In Pakistan, derivatives on financial assets trade on the Pakistan Stock Exchange, while commodity derivatives trade on the Pakistan Mercantile Exchange.
1. The document discusses various derivatives trading concepts such as futures contracts, forward contracts, and options. It explains that futures contracts are standardized agreements to buy or sell an asset at a specified price on a future date, while forward contracts are customized agreements with physical delivery of the asset.
2. Options are described as contracts that give the buyer the right but not the obligation to buy or sell an asset at a specified price on or before the expiration date. The main types are calls, which are rights to buy, and puts, which are rights to sell.
3. Participants in futures markets are identified as hedgers who protect their positions, speculators who take risks seeking profits, and arbitrageurs who exploit
The document provides an overview of derivatives, including their basic uses and types. Derivatives are financial instruments whose value is based on an underlying asset. They are used for hedging risk exposure and speculation. Common types of derivatives include futures, forwards, options, and swaps. Options give the buyer the right but not obligation to buy or sell an asset, while futures and forwards require the exchange of the asset. Swaps involve exchanging cash flows over time, such as interest rates or currencies.
This document provides an overview of various types of financial derivatives, including futures, forwards, options, and swaps. It defines derivatives as financial instruments whose value is derived from an underlying security such as a commodity, stock, bond, or other derivative. The document explains the obligations associated with each type of derivative contract and discusses how they can be used for hedging risk or speculative purposes. It also outlines some key concepts for understanding derivatives markets.
The document summarizes the history and types of derivatives in India. It discusses:
- Futures trading began in India in 1875 through the Bombay Cotton trade association. The government later banned some derivatives until 1995-1999 when regulations were amended.
- Derivatives include futures, forwards, swaps, and options, whose values are derived from underlying assets. Common underlying assets include commodities, currencies, interest rates and stocks.
- The main purpose of derivatives is to transfer risk from one party to another through hedging. This allows farmers, for example, to guarantee prices and encourage investment.
The document discusses various commodity derivatives markets and exchanges around the world. It provides details on the National Commodity and Derivatives Exchange of India (NCDEX) and Multi Commodity Exchange of India (MCX), including the commodities traded and clearing/settlement processes. It also summarizes information on the Tokyo Commodity Exchange (TOCOM) and contracts traded there such as gold and rubber. Finally, it outlines the Dalian Commodities Exchange in China and types of contracts traded including corn, soybeans, and crude soybean oil.
This document discusses option Greeks, which are measures of how the price of an option changes in response to changes in other variables such as the price of the underlying asset, volatility, and time to expiration. It defines the key Greeks - delta, gamma, theta, and vega - and provides formulas for calculating each one. It also discusses how understanding Greeks allows options traders to hedge positions against risks and maintain delta neutrality.
An options contract gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified strike price on or before the expiration date. There are call and put options. A call option allows buying the asset, while a put option allows selling the asset. The buyer pays a premium to the seller for this right. The profit/loss of the buyer and seller depends on whether the option expires in or out of the money. The buyer's potential profit is unlimited but their loss is limited to the premium paid, whereas for the seller the potential loss is unlimited but profit is limited to the premium received.
IABF Education Institute gives to you details about Stock Market details, How to know about stock markets, What is Stock Market, Who is broker, What is D/Mat A/C, Functions of Brokers, Know about NIFTY,
Basics of Indian Stock Market & its Trading MechanismsShilpi Maheshwari
The document discusses the key concepts related to stock markets and trading mechanisms in India. It provides details on the history and development of stock exchanges in India, starting from the formation of the Bombay Stock Exchange in 1875. It describes the functions of stock exchanges and different types of trading systems, orders, and market participants like speculators. It also discusses important concepts like depositories, stock indices, and the role of regulatory bodies like SEBI in the Indian stock market.
IFRS 16, issued in January 2016, changes lease accounting requirements for lessees. It requires all leases to be reported on the balance sheet as a right-of-use asset and corresponding lease liability. Previously, operating leases were reported off-balance sheet. The new standard aims to provide a more faithful representation of a company's financial position by bringing operating leases onto the balance sheet. For lessees, IFRS 16 eliminates the classification of leases as either operating or finance leases and requires lessees to recognize a right-of-use asset and a financial liability for all leases unless the lease term is 12 months or less or the underlying asset is of low value. Exemptions
The document provides information on operations research and the assignment problem. It discusses the steps to solve an assignment problem, which include: (1) writing the problem in a matrix form, (2) obtaining a reduced cost matrix through row and column operations, and (3) making assignments on a one-to-one basis by considering zeros in rows and columns. It also addresses issues like unbalanced matrices, maximization problems, and infeasible assignments.
This document defines various derivatives instruments and concepts. It begins by explaining that derivatives derive their value from an underlying asset and include futures, forwards, and options. It then discusses the different types of traders in derivatives markets including hedgers, speculators, and arbitrageurs. The document also compares over-the-counter (OTC) derivatives to exchange-traded derivatives and outlines some of the economic benefits of using derivatives. It provides examples and definitions for specific derivative types like forwards, futures, and options.
This document provides an introduction to options, including the different types (calls and puts), how they work, key terminology, and factors that influence pricing. An option gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before expiration. The buyer pays a premium to the seller for this right. Key terms discussed include strike price, expiration date, and long/short positions. Factors like time to expiration, volatility, and interest rates impact an option's price. The Black-Scholes model is commonly used to price options based on these variables.
Derivatives are financial instruments whose value is derived from an underlying asset. Forward and futures contracts are types of derivatives that allow parties to lock in a price today to purchase or sell an asset in the future. A forward contract is a customized over-the-counter agreement between two parties, while a futures contract is traded on an exchange with standardized terms. Both require mark-to-market adjustments and margin payments to mitigate risks from price fluctuations until contract settlement.
The document discusses the differences between stock markets and share markets, which essentially mean the same thing. It describes stocks as units of ownership in a company that can be traded, while shares are certificates of ownership issued by companies to raise funds. The stock market is an organized market for trading stocks and shares of government bodies and corporations. It also defines primary and secondary markets, as well as different types of stocks and indexes used in Indian stock markets like the BSE and NSE.
Options are a type of derivative security. They are a derivative because the price of an option is intrinsically linked to the price of something else. Specifically, options are contracts that grant the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date. The right to buy is called a call option and the right to sell is a put option. People somewhat familiar with derivatives may not see an obvious difference between this definition and what a future or forward contract does. The answer is that futures or forwards confer both the right and obligation to buy or sell at some point in the future. For example, somebody short a futures contract for cattle is obliged to deliver physical cows to a buyer unless they close out their positions before expiration. An options contract does not carry the same obligation, which is precisely why it is called an “option.”
Derivatives are financial instruments whose value is derived from an underlying asset such as a commodity, currency, bond, or stock. There are several types of derivatives including forwards, futures, and options. A forward is a customized contract where the buyer agrees to purchase an asset at a set price on a future date. Futures are standardized forward contracts that are exchange-traded. Options provide the right but not the obligation to buy or sell the underlying asset at a predetermined price on or before the expiration date.
This document summarizes different types of swap contracts. It begins with an overview of interest rate swaps, including how they allow entities to exchange fixed and variable rate financing. It then describes currency swaps, commodity swaps, credit default swaps, and equity swaps. For each type, it provides a definition and example to illustrate how the swap works. The presentation was given by Paulo Martins and Vilma Jordão to explain the role of swap contracts and how they can help companies manage financial risks.
The document defines options and futures contracts. It provides examples of different types of option contracts and discusses the key characteristics of options, including call and put options. It defines call options as giving the buyer the right to purchase an underlying asset and put options as giving the right to sell. It also discusses in-the-money, at-the-money, and out-of-the-money options based on the exercise price compared to the market price. The document then defines futures contracts and lists types of commodity and financial futures. It concludes by explaining the primary difference between options and futures - that options provide the right but not obligation to buy/sell the underlying asset, while futures contracts obligate the holder to fulfill the contract terms
This document provides an overview of financial derivatives, including:
- A derivative is a financial instrument whose value is derived from an underlying asset. Common types of derivatives include forwards, futures, options, and swaps.
- Derivatives can be traded over-the-counter (OTC) between two parties or on an exchange.
- In Pakistan, derivatives on financial assets trade on the Pakistan Stock Exchange, while commodity derivatives trade on the Pakistan Mercantile Exchange.
1. The document discusses various derivatives trading concepts such as futures contracts, forward contracts, and options. It explains that futures contracts are standardized agreements to buy or sell an asset at a specified price on a future date, while forward contracts are customized agreements with physical delivery of the asset.
2. Options are described as contracts that give the buyer the right but not the obligation to buy or sell an asset at a specified price on or before the expiration date. The main types are calls, which are rights to buy, and puts, which are rights to sell.
3. Participants in futures markets are identified as hedgers who protect their positions, speculators who take risks seeking profits, and arbitrageurs who exploit
The document provides an overview of derivatives, including their basic uses and types. Derivatives are financial instruments whose value is based on an underlying asset. They are used for hedging risk exposure and speculation. Common types of derivatives include futures, forwards, options, and swaps. Options give the buyer the right but not obligation to buy or sell an asset, while futures and forwards require the exchange of the asset. Swaps involve exchanging cash flows over time, such as interest rates or currencies.
This document provides an overview of various types of financial derivatives, including futures, forwards, options, and swaps. It defines derivatives as financial instruments whose value is derived from an underlying security such as a commodity, stock, bond, or other derivative. The document explains the obligations associated with each type of derivative contract and discusses how they can be used for hedging risk or speculative purposes. It also outlines some key concepts for understanding derivatives markets.
The document summarizes the history and types of derivatives in India. It discusses:
- Futures trading began in India in 1875 through the Bombay Cotton trade association. The government later banned some derivatives until 1995-1999 when regulations were amended.
- Derivatives include futures, forwards, swaps, and options, whose values are derived from underlying assets. Common underlying assets include commodities, currencies, interest rates and stocks.
- The main purpose of derivatives is to transfer risk from one party to another through hedging. This allows farmers, for example, to guarantee prices and encourage investment.
The document discusses various commodity derivatives markets and exchanges around the world. It provides details on the National Commodity and Derivatives Exchange of India (NCDEX) and Multi Commodity Exchange of India (MCX), including the commodities traded and clearing/settlement processes. It also summarizes information on the Tokyo Commodity Exchange (TOCOM) and contracts traded there such as gold and rubber. Finally, it outlines the Dalian Commodities Exchange in China and types of contracts traded including corn, soybeans, and crude soybean oil.
This document discusses option Greeks, which are measures of how the price of an option changes in response to changes in other variables such as the price of the underlying asset, volatility, and time to expiration. It defines the key Greeks - delta, gamma, theta, and vega - and provides formulas for calculating each one. It also discusses how understanding Greeks allows options traders to hedge positions against risks and maintain delta neutrality.
An options contract gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified strike price on or before the expiration date. There are call and put options. A call option allows buying the asset, while a put option allows selling the asset. The buyer pays a premium to the seller for this right. The profit/loss of the buyer and seller depends on whether the option expires in or out of the money. The buyer's potential profit is unlimited but their loss is limited to the premium paid, whereas for the seller the potential loss is unlimited but profit is limited to the premium received.
IABF Education Institute gives to you details about Stock Market details, How to know about stock markets, What is Stock Market, Who is broker, What is D/Mat A/C, Functions of Brokers, Know about NIFTY,
Basics of Indian Stock Market & its Trading MechanismsShilpi Maheshwari
The document discusses the key concepts related to stock markets and trading mechanisms in India. It provides details on the history and development of stock exchanges in India, starting from the formation of the Bombay Stock Exchange in 1875. It describes the functions of stock exchanges and different types of trading systems, orders, and market participants like speculators. It also discusses important concepts like depositories, stock indices, and the role of regulatory bodies like SEBI in the Indian stock market.
IFRS 16, issued in January 2016, changes lease accounting requirements for lessees. It requires all leases to be reported on the balance sheet as a right-of-use asset and corresponding lease liability. Previously, operating leases were reported off-balance sheet. The new standard aims to provide a more faithful representation of a company's financial position by bringing operating leases onto the balance sheet. For lessees, IFRS 16 eliminates the classification of leases as either operating or finance leases and requires lessees to recognize a right-of-use asset and a financial liability for all leases unless the lease term is 12 months or less or the underlying asset is of low value. Exemptions
The document provides information on operations research and the assignment problem. It discusses the steps to solve an assignment problem, which include: (1) writing the problem in a matrix form, (2) obtaining a reduced cost matrix through row and column operations, and (3) making assignments on a one-to-one basis by considering zeros in rows and columns. It also addresses issues like unbalanced matrices, maximization problems, and infeasible assignments.
Assignment Chapter - Q & A Compilation by Niraj ThapaCA Niraj Thapa
My name is Niraj Thapa. I have compiled Assignment Chapter including SM, PM & Exam Questions of AMA.
You feedback on this will be valuable inputs for me to proceed further.
This document provides an introduction to options and futures markets. It defines key terms like derivatives, underlying assets, calls, puts, premiums, strikes, expiration dates, and exercise types. Examples are given to illustrate put and call payoffs and profits at different underlying price levels. Common options strategies like bull spreads are also explained. The document covers fundamental options concepts like moneyness, break-even points, and how options values are determined.
- The document is a test bank containing questions pertaining to derivatives.
- Questions follow a numbering system indicating the chapter and question number.
- Quiz and exam questions will be similar in style to those found in the test bank.
- By default, interest rates and dividend yields are assumed to be quoted on a per annum and continuously compounded basis.
This document discusses various hedging strategies using futures contracts. It describes long and short hedges to lock in future purchase or sale prices of assets. Arguments in favor of hedging include reducing risks from market variables, while arguments against include shareholders already being diversified and increased risk if competitors do not hedge. Examples illustrate how futures hedging works for both long and short hedges. The document also discusses cross hedging using different but correlated assets, calculating optimal hedge ratios, and hedging equity portfolios using stock index futures.
MGS futures contracts allow investors to take positions on Malaysian government bond (MGS) prices without physically holding the bonds. Institutional investors can use MGS futures as a temporary substitute when the physical bond market is illiquid. Speculators provide liquidity to the market by taking long or short positions based on their views of how interest rates and bond prices may move in the future. Hedgers use MGS futures to offset risks to their bond portfolios from potential interest rate changes. The document provides examples of how an institutional investor, speculator, and hedger might use MGS futures contracts.
This document discusses the determination of forward and futures prices. It introduces the concepts of investment assets versus consumption assets and explains how short selling works. It then provides the basic formulas for relating the forward or futures price to the spot price based on interest rates. The formulas are adapted for assets that pay income or have storage costs. Arbitrage opportunities that can arise when the theoretical relationship between spot and forward/futures prices does not hold are also discussed.
Futures contracts are exchange-traded contracts that specify the quality, quantity, and delivery details of an underlying asset. They are settled daily based on changes in the spot price. Margins are deposited to minimize the risk of default. Key features of futures include daily settlement, offsetting trades to close positions before maturity, and delivery or cash settlement at expiration unless closed out earlier. Basis risk arises from uncertainty about the relationship between futures and spot prices when hedges are closed out.
The document discusses the Black-Scholes-Merton model for valuing stock options. It describes the random walk assumption used in the model and how it implies stock prices will follow a lognormal distribution. The Black-Scholes formula for option prices is presented, which values options based on the stock price, strike price, risk-free rate, time to expiration, and volatility. The concept of implied volatility is introduced, which is the volatility input to the Black-Scholes formula that produces the market price. Adjustments to the model for dividends are also covered.
An interest rate swap is an agreement to exchange cash flows at specified future times according to certain rules. In a typical "plain vanilla" interest rate swap, one party pays a fixed interest rate on a notional principal while the other party pays a floating rate, usually based on LIBOR. Currency swaps involve exchanging principal amounts in different currencies in addition to periodic interest payments. Swaps allow parties to transform fixed rate obligations/investments into floating rate or to gain exposure to another currency. Swaps can be valued by comparing the cash flows of a fixed rate bond to a floating rate bond or as a portfolio of forward rate agreements.
The document discusses various types of interest rate swaps and how to value them. It begins by explaining how the standard approach values plain vanilla interest rate and currency swaps by assuming forward rates will be realized. It then describes how this approach can also value swaps with variations like different payment frequencies or floating rates. More complex swaps like LIBOR-in-arrears, CMS, differential, and equity swaps require adjustments to the standard approach for accurate valuation. The document also discusses swaps with embedded options and other unique types of swaps.
Finance project report on a study on financial derivatives ...Mba projects free
This document is a study on financial derivatives (futures and options) submitted for a Master's degree in Business Administration. It discusses the emergence and growth of derivatives markets as a way for economic agents to hedge against price risks. Derivatives derive their value from an underlying asset and are used by banks, firms, and investors for hedging, speculation, and arbitrage. The main types of derivatives are futures, options, warrants, LEAPS, baskets, and swaps. The study analyzes derivatives trading in India and examines how it impacts market volatility.
The document provides an overview of derivatives markets, including the key terms and participants. It discusses how derivatives help transfer and hedge risks, facilitate price discovery, and catalyze economic activity. The main types of derivatives are forwards, futures, swaps, and options. Forwards and swaps are over-the-counter derivatives privately negotiated between parties, while futures and options are exchange-traded standardized contracts. Hedgers use derivatives to offset price risks, while speculators and arbitrageurs take positions to profit from price movements.
A derivative is a financial instrument whose value is derived from the value of another asset, known as the underlying. There are three main types of traders in the derivatives market: hedgers who use derivatives to reduce risk, speculators who trade for profits, and arbitrageurs who take advantage of price discrepancies across markets. Derivatives can be traded over-the-counter (OTC) or on an exchange, and provide various economic benefits such as risk reduction and enhanced market liquidity.
A derivative is a financial instrument whose value is derived from the value of an underlying asset. Derivatives include forwards, futures, options, and swaps. Forwards and swaps are traded over-the-counter (OTC), while futures and options are traded on exchanges. Options give the holder the right but not obligation to buy or sell the underlying asset. Swaps involve exchanging cash flows of one asset for another at periodic intervals. Derivatives allow investors to hedge risk or speculate on price movements of the underlying asset.
A derivative is a financial instrument whose value is derived from the value of an underlying asset. Derivatives include forwards, futures, options, and swaps. Forwards and futures are contracts to buy or sell an asset at a future date, while options provide the right but not obligation to buy or sell. Swaps involve exchanging cash flows of one asset for another. Derivatives can be traded over-the-counter or on an exchange, with exchange-traded derivatives using standardized contracts.
This document provides an overview of derivatives, including the key participants in the derivatives market, types of derivative contracts, and some examples. It discusses forwards, futures, options, and swaps. Forwards and futures are distinguished, with examples provided. Call and put options are explained using examples. Interest rate swaps and currency swaps are also briefly covered. The document then discusses expiry dates, trading, and final settlement of futures and options contracts. It concludes by noting some of the main risks associated with derivatives.
Derivatives are financial instruments whose value is derived from an underlying asset. The three main types of derivatives are forwards, futures, and options. Forwards are customized contracts traded over-the-counter, while futures are standardized contracts traded on an exchange. Options give the holder the right but not obligation to buy or sell the underlying asset. Swaps involve exchanging cash flows of one party's financial instrument for those of another party. Derivatives allow parties to manage financial risks and speculate in the market.
The document discusses various derivatives contracts including forwards, futures, options, swaps, and their key characteristics. A forward contract involves a customized, over-the-counter agreement to buy or sell an asset at a future date for a predetermined price. A future is a standardized forward contract traded on an exchange. Options provide the right but not obligation to buy or sell an asset. Swaps involve exchanging cash flows of different assets or currencies to hedge risks.
The document provides an overview of risk management with futures contracts, explaining key concepts like hedging, short and long positions, forwards versus futures, margins, mark-to-market process, and how taking opposite positions in the cash and futures markets can help reduce risk for buyers and sellers. Futures contracts standardize terms to allow for trading on exchanges, use a clearing house to minimize counterparty risk, require daily margin payments to settle profits and losses, and can be closed out before expiration.
Derivatives can be used to manage financial risk. Common derivatives include options, forward contracts, futures contracts, and swaps. Derivatives allow firms to hedge risks like foreign exchange risk, interest rate risk, and commodity price risk. For example, an oil company can use put options to hedge against falling oil prices. Forward contracts lock in future exchange rates. Futures contracts are similar to forwards but are traded on exchanges. Swaps allow exchange of cash flows to modify risk exposure. Derivatives are widely used by large companies to reduce cash flow volatility and financial distress costs through hedging.
Derivatives are financial instruments whose value is derived from an underlying asset. The three main types of traders in derivatives markets are hedgers who use derivatives to reduce risk, speculators who trade for profits, and arbitrageurs who exploit price discrepancies across markets. Derivatives can be traded over-the-counter (OTC) through privately negotiated contracts or on exchanges through standardized contracts. Common types of derivatives include forwards, futures, options, and swaps. Forwards and futures are binding agreements to buy or sell an asset in the future at an agreed upon price, while options provide the right but not obligation to buy or sell. Swaps involve exchanging cash flows of one asset for another.
The document discusses various financial instruments in India including the capital market, money market, stock exchanges, commodity exchanges, derivatives such as futures, forwards and options. It provides details on the key features and differences between these instruments such as forwards being a private agreement while futures are exchange-traded and standardized. It also discusses concepts like margin requirements, order types and players in the financial markets like hedgers, speculators and arbitrageurs.
Forward and futures contracts allow parties to lock in a price today for an asset to be purchased or sold in the future. Futures contracts are traded on exchanges and include margin requirements and daily price adjustments to account for price changes, while forward contracts are negotiated privately. These derivatives can be used to speculate by betting on price movements or to hedge and reduce risk from price changes in assets a party needs to buy or sell. The document compares using futures versus options for hedging and speculating purposes.
The document discusses forward contracts and interest rate parity. It defines a forward contract as an agreement to deliver a specified amount of currency at a future date at a fixed exchange rate. The purpose of forwards is to hedge against exchange rate risk. Interest rate parity theory states that the forward rate should differ from the spot rate by an amount equal to the interest rate differential between two countries. Covered interest arbitrage may occur if the forward premium/discount does not equal the interest rate differential.
This document defines derivatives and describes their key features and types. It explains that a derivative is a financial instrument whose value is based on an underlying asset. The main types of derivatives discussed are forwards, futures, swaps, and options. It provides examples of each type and outlines their key characteristics. It also discusses derivative markets in Pakistan and how derivatives can help reduce risk but also enable speculation.
This document provides an introduction to financial derivatives. It defines derivatives as financial instruments whose price is dependent on an underlying asset. Common underlying assets include stocks, bonds, commodities, currencies, and interest rates. Derivatives allow parties to mitigate risks related to price movements of these assets. The document discusses various types of derivatives including forwards, futures, options, and swaps. It also covers key concepts like hedging strategies, margin requirements, and historic derivative-related failures like Barings Bank and Metallgesellschaft.
Financial derivatives are financial instruments linked to an underlying asset or indicator. Derivatives allow parties to trade financial risks independently from owning the underlying asset. There are several types of derivatives, including futures, forwards, options, and swaps. Futures are standardized forward contracts traded on an exchange. Options give the holder the right but not obligation to buy or sell the underlying asset. Swaps involve exchanging cash flows between two parties over time based on a notional principal amount. Derivatives are used by hedgers, speculators, and arbitrageurs to manage risk, seek profit, and exploit pricing discrepancies.
There are three main types of traders in futures markets - hedgers who seek to reduce risk, speculators who take on risk in hopes of profiting from price movements, and arbitrageurs who exploit temporary mispricings across related markets. Futures contracts are standardized to specify the deliverable asset, amount, location, and timing of delivery. Daily mark-to-market and margin adjustments help minimize the risk of default on futures positions.
1) Futures contracts are agreements to buy or sell an asset at a predetermined price on a specified future date. Commodity futures involve agricultural and industrial goods, while financial futures are based on stock indexes, interest rates, and currencies.
2) Futures contracts are used by hedgers seeking to offset price risk and speculators hoping to profit from price changes. Clearinghouses associated with exchanges guarantee trades and regulate deliveries.
3) The theoretical futures price is determined by arbitrage and equals the current cash price plus the cost of carry until the futures contract expires. Basis risk and cross-hedging risk can reduce the effectiveness of hedging strategies using futures.
This document provides an overview of derivatives and the capital markets in India. It defines key terms like the primary and secondary markets, stock exchanges, indices, and types of derivatives like forwards, futures, options, and swaps. It describes the functions and objectives of derivatives for hedging risk and speculation. The history of derivatives trading in India is summarized, along with the major participants like hedgers, speculators, and arbitrageurs.
I express my sincere respect to the authors and my teachers from whom I remain updated in this segment. Due care have been taken so as not to violate the copyright issues.
The document discusses different perspectives on corporate dividend policy. It outlines the facts about dividend payouts including types of dividends and how they are distributed. It then discusses two schools of thought on dividends: the dividend irrelevance theory proposed by Miller and Modigliani, which argues that dividends do not affect firm value; and the good-bad signaling theory, which posits that dividends can signal management confidence or financial health. The document also notes the increasing trend of share repurchases compared to dividends and debates whether repurchases or dividends are better for investors.
Triennial Central Bank Survey On FOREX 2007CA Niraj Thapa
The document summarizes the findings of the 2007 Triennial Central Bank Survey on foreign exchange and derivatives market activity. Key findings include:
1) Turnover in traditional foreign exchange markets grew unprecedentedly by 69% since 2004 to $3.2 trillion daily in April 2007. This increase was much stronger than the 2001-2004 period.
2) Turnover in over-the-counter (OTC) derivatives markets increased for interest rate contracts but decreased for foreign exchange contracts. Total notional amounts outstanding of OTC derivatives reached $417 trillion in June 2007.
3) By June 2007, the total notional value of outstanding credit default swaps contracts grew to $34 trillion, more than doubling since 2004
Here are the key steps of the high-low method without inflation:
1) Select the highest and lowest levels of activity from the available cost and activity data. In this case, the highest activity level is 20 units and the lowest is 10 units.
2) Calculate the change in total cost between the highest and lowest activity levels. Here, the change in total cost is Rs. 200 (Rs. 600 - Rs. 400).
3) Calculate the change in activity level between the highest and lowest points. Here, the change in activity is 10 units (20 units - 10 units).
4) Calculate the variable cost per unit by dividing the change in total cost by the change in activity level. Here, the
This document summarizes five theories of international finance:
1) Interest Rate Parity relates spot and forward exchange rates to interest rate differentials between two countries. It states that interest rate differences should equal the forward premium or discount.
2) Purchasing Power Parity argues that exchange rates should adjust so that equivalent goods cost the same across countries after accounting for exchange rates and price levels. Relative PPP focuses on how inflation rate differences impact exchange rate changes.
3) The Fisher Effect describes the relationship between nominal interest rates, real interest rates, and inflation. It posits that nominal rates will adjust one-for-one with expected inflation so that real rates remain unchanged.
4) The International Fisher Effect extends
The document provides information on the key changes introduced in the revised Schedule VI format for balance sheets and statements of profit and loss in India. Some of the major changes include: (1) Replacing 'sources of funds' and 'application of funds' with 'equity and liabilities' and 'assets'; (2) Classifying assets and liabilities as current or non-current based on operating cycle; (3) Prescribing separate line items and additional disclosures for items like cash flow statements, intangible assets, taxes, and related party transactions. The document also explains the revised definitions and disclosure requirements for items like reserves, investments, provisions, and borrowings in the balance sheet.
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Falcon stands out as a top-tier P2P Invoice Discounting platform in India, bridging esteemed blue-chip companies and eager investors. Our goal is to transform the investment landscape in India by establishing a comprehensive destination for borrowers and investors with diverse profiles and needs, all while minimizing risk. What sets Falcon apart is the elimination of intermediaries such as commercial banks and depository institutions, allowing investors to enjoy higher yields.
In a tight labour market, job-seekers gain bargaining power and leverage it into greater job quality—at least, that’s the conventional wisdom.
Michael, LMIC Economist, presented findings that reveal a weakened relationship between labour market tightness and job quality indicators following the pandemic. Labour market tightness coincided with growth in real wages for only a portion of workers: those in low-wage jobs requiring little education. Several factors—including labour market composition, worker and employer behaviour, and labour market practices—have contributed to the absence of worker benefits. These will be investigated further in future work.
1. Elemental Economics - Introduction to mining.pdfNeal Brewster
After this first you should: Understand the nature of mining; have an awareness of the industry’s boundaries, corporate structure and size; appreciation the complex motivations and objectives of the industries’ various participants; know how mineral reserves are defined and estimated, and how they evolve over time.
Independent Study - College of Wooster Research (2023-2024) FDI, Culture, Glo...AntoniaOwensDetwiler
"Does Foreign Direct Investment Negatively Affect Preservation of Culture in the Global South? Case Studies in Thailand and Cambodia."
Do elements of globalization, such as Foreign Direct Investment (FDI), negatively affect the ability of countries in the Global South to preserve their culture? This research aims to answer this question by employing a cross-sectional comparative case study analysis utilizing methods of difference. Thailand and Cambodia are compared as they are in the same region and have a similar culture. The metric of difference between Thailand and Cambodia is their ability to preserve their culture. This ability is operationalized by their respective attitudes towards FDI; Thailand imposes stringent regulations and limitations on FDI while Cambodia does not hesitate to accept most FDI and imposes fewer limitations. The evidence from this study suggests that FDI from globally influential countries with high gross domestic products (GDPs) (e.g. China, U.S.) challenges the ability of countries with lower GDPs (e.g. Cambodia) to protect their culture. Furthermore, the ability, or lack thereof, of the receiving countries to protect their culture is amplified by the existence and implementation of restrictive FDI policies imposed by their governments.
My study abroad in Bali, Indonesia, inspired this research topic as I noticed how globalization is changing the culture of its people. I learned their language and way of life which helped me understand the beauty and importance of cultural preservation. I believe we could all benefit from learning new perspectives as they could help us ideate solutions to contemporary issues and empathize with others.
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2. Elemental Economics - Mineral demand.pdfNeal Brewster
After this second you should be able to: Explain the main determinants of demand for any mineral product, and their relative importance; recognise and explain how demand for any product is likely to change with economic activity; recognise and explain the roles of technology and relative prices in influencing demand; be able to explain the differences between the rates of growth of demand for different products.
2. Next SlideNiraj Thapa
Introduction
Types Of Financial Derivatives
Hedging Strategies Using Futures
Option Strategies
Option Pricing
Why To Use Derivatives
Users Of Derivatives
Contents At A Glance
3. Next SlideNiraj Thapa
Introduction Markets in Derivatives
Exchange-traded
oStandardized* contracts are traded
o Regulated by exchange boards as:
E.g. CBOT (The Chicago Board of Trade)
Target of CBOT Initially: bring farmers and merchants
together
CME (Chicago Mercantile Exchange)
CBOE (Chicago Board Options Exchange)
*Standard here means – Quantity pre specified
followed by pre specified maturity.
Over-the-counter
(An alternative to exchange)
oBased on telephone- and computer-
linked network of dealers.
o Conversations are generally tapped so as
to avoid future disputes- since non-
standardized contracts being traded.
o typically much larger trades
o participants are free to negotiate any
mutually attractive deal
o contract may not be honored
sometimes.
4. Next SlideNiraj Thapa
Size of OTC and Exchange-Traded Markets
Source: Bank for International Settlements. Chart shows total principal amounts
for OTC market and value of underlying assets for exchange market
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S.No. Basis Exchange Traded Market OTC (Over the counter market)
(i) Product Standard Non-standard
(ii) Pricing More transparent Less transparent
(iii) MTM Easy Difficult
(iv) Settlement risk The Exchange Contracting parties
(v) Negotiation Marketwide One-to-one
(vi) Example BSE, NSE etc. Forex Market
OTC & ET Products
6. Next SlideNiraj Thapa
Basically derivatives are agreements or contracts between two (or more) parties that has a
value determined by the price of something else.
A derivative is a-
financial instrument or security
whose payoffs and values are derived from, or depend on
Another financial instrument or security
And the pay off is derived from that underlying.
Introduction to Derivatives
7. The underlying asset could be a financial asset such as currency, stock
and market index, an interest bearing security or a physical commodity.
Payment may be in Currency, securities, a physical entity such as gold or
silver, an agricultural product such as wheat or pork, a transitory
commodity such as communication bandwidth or energy.
For example, a bushel of corn is not a derivative; it is a commodity with a
value determined by the price of corn.
Eg. If you enter into an agreement with a friend that says: If the price of a
bushel of corn in one year is greater than Rs.300, you will pay the friend
Rs.100 . If the price of com is less than Rs.300, then the friend will pay you
Rs. 100 . This is a derivative in the sense that you have an agreement with
a value depending on the price of something else (corn, in this case).
9. Next SlideNiraj Thapa
Forward Contracts (Spot Contracts)
Simply, Forward Contracts Features:
tailor made contract Customer designed contracts
entered today (i.e. contract sixe, expiration
for purchase (sell) date and the asset type and quality)
of an asset in future not available in public domain
for a certain price agreed today
Trading: Over-the-counter market
One party-In long Position (Buyer)
Another- In short position (Seller)
Whether to buy or sell
The underlying asset
The maturity or the settlement date
The delivery price
10. Next SlideNiraj Thapa
See Practically
USD/INR Bid Offer
Spot
1-month forward
3-month forward
6-month forward
1-year forward
70.4452
70.4435
70.4402
70.4353
70.4262
70.4456
70.4440
70.4407
70.4359
70.4268
Bid:
bank is
ready
to buy
USD
Offer:
Bank is
ready
to sell
USD
The table shows the quote given by a bank.
Forward Contracts are used to hedge foreign currency risk.
Suppose a person is receiving $10000 six months later from now, to be safe from price fluctuations
in days to come he may enter into an agreement with the bank to sell the $10000 today.
As per the rates given:
He will sell each $ @ INR 70.4353, total =70.4353*10000=704353
11. Next SlideNiraj Thapa
Payoffs From Forward Contracts
Two
Possibilities
Assume (from above table) the real consequences on the expiry date.
The actual price prevailing on the expiry date has nothing to with the forward contract as your
payment/receiving has been previously fixed). (These payoffs can be positive or negative.)
$Price may rise $ Price may fall
(Say 1$ =INR 70.50)
Negative value to the
contract
(Say 1$ = INR 70.30)
Positive Value.
12. Next SlideNiraj Thapa
Profit
Price of Underlying
at Maturity, ST
Profit
Price of Underlying
at Maturity, ST
Profit from a
Long Forward Position
Profit from a
Short Forward Position
13. Next SlideNiraj Thapa
Futures
Definition
• An agreement between two parties
• to buy or sell specified asset
• In future
• With settlement at
• various future dates
Features
• Exchange traded product
• specified contract size and
specified delivery date
• Settled daily
• Settlement-in cash or physical
• Mostly closed out before maturity
• Futures prices - reported in the
financial press
• mark-to-the-market provisions
14. Next SlideNiraj Thapa
SBI Future Seller SBI Future Buyer
Right: To receive the agreed price
Obligation: To deliver the underlying
Right: To take delivery of the underlying
Obligation: To pay the contracted price
Mr. A enters into a contract with Mr. B
Position:
Long in SBI Future &
Underlying
Position:
Short in SBI Future &
Underlying
15. Next SlideNiraj Thapa
Concept of Margins
amount payable by both parties.
recovered to cover one day maximum
loss
can be in the form of cash or other liquid
assets
[Generally, we do not deposit cash]
Calculated daily & Settled in cash
Overcomes the dark side of forwards.
minimize the chance of default
If the price rises, the seller has an
incentive to default on a forward
contract. But in future, after paying the
clearinghouse, the seller of a futures
contract has little reason to default.
changes in the value recognized daily,
there is no accumulation of loss
Default rate is reduced when the
investors do not know each other.
16. Next SlideNiraj Thapa
The agreement will be honored by the CH
To protect itself the CH demands that
An initial collateral amount is deposited to cover future losses
A futures account is marked to market daily. Daily margin increase to cover unrealized losses
from daily market movements
No party will incur a big loss at maturity
Categories of futures contracts
• Agricultural e.g. wheat, cotton, cattle.
• Metals and petroleum e.g. platinum, copper, natural gas, crude oil.
• Financial e.g. foreign currency, stock index, interest rate.
• Others e.g. electricity, catastrophe, swap
Credit Risk Mitigation
17. SETTLEMENT IN FUTURES
ON DAILY BASIS AT EXPIRY DATE
MTM MARGIN MTM MARGIN
BASED ON DAILY
SETTLEMENT PRICE
BASED ON *FUTURE
SETTLEMENT PRICE
DECIDED BY THE
MARKET (STOCK
EXCHANGE)
* FSP IS ALWAYS EQUAL TO SPOT PRICE OF
THE UNDERLYING AT EXPIRY.
Note:OverallProfitwillbeFSP-ContractedPrice
19. Next SlideNiraj Thapa
Long Trader
Broker
Clearing House
Member
Clearing House
Clearing House
Member
Broker
Long Trader
Broker
Clearing House
Member
Clearing House
Clearing House
Member
Broker
Short Trader
Short Trader
Margin Cash Flows
When Futures Price Decreases When Futures Price Increases
21. Next SlideNiraj Thapa
Forward Contracts Vs. Futures Contracts
Basis Forward Futures
Exchange Traded on over-the-counter market Traded on an exchange
Counterparty Counterparty in the forward
agreement
Clearinghouse
Transaction
Timing
Transact when purchased and on the
settlement date
Marked-to-market every day
Delivery Delivery or final cash settlement Contract is usually closed out usually
takes place prior to maturity
Credit Risk Some credit risk may arise Virtually no credit risk
Regulation Private, unregulated transactions Highly regulated
Liquidity Illiquid Highly Illiquid
Delivery Dates Usually one specified delivery date Range of delivery dates
22. Next SlideNiraj Thapa
Remember:
The hedge has the same basic effect if delivery is
allowed to happen. However, making or taking
delivery can be a costly business so delivery is not
usually made even when the hedger keeps the
futures contract until the delivery month.
Hedging Strategies Using Futures
23. Next SlideNiraj Thapa
• Take a position that neutralizes a particular
risk as far as possible
AIM
• That completely eliminates the risk.
• Perfect hedges are rare practically
PERFECT
HEDGE
24. Short Position in future Contracts
Appropriate when the hedger already owns an asset and expects to sell it.
Used when an asset is not owned right now but will be owned at some
time in the future.
E.g. Used by a farmer who owns some hogs and knows that they will be
ready for sale.
An Indian exporter will be receiving euros in three months.
He will realize a gain if the euro increases in value relative to the INR and
will sustain a loss if the euro decreases in value relative to the INR.
A short futures position leads to a loss if the euro increases in value and a
gain if it decreases in value.
It has the effect of offsetting the exporter's risk.
SHORTHEDGES
25. Use futures contracts than to buy the gold in the spot market as he has to pay $ 150
instead of $120 per pound and will incur both interest costs and storage costs
Long position in future contracts
-appropriate when a company knows it will have to purchase a certain asset in
the future and wants to lock in a price now.
-partially offset an existing short position
See Practically:
A trader needs 1000 pounds of gold after 3 months from now to meet a
certain contract.
Contract Size: 250 pounds
Spot Price: $150 /pound
3-M Future Price: $120 /pound
The trader can hedge by taking a long position in 4 future contracts to be
delivered in 3 months from now.
This strategy locked the price @120 cents
If the price of gold in 3 months time is 125
Gain = (125-120) x 1000 = $5000
LONGHEDGEADVICE
26. Next SlideNiraj Thapa
Long Hedge for Purchase
Define:
F1 : Futures price at time hedge
is set up
F2 : Futures price at time asset is
purchased
S2 : Asset price at time of
purchase
b2 : Basis at time of purchase
Short Hedge for Sale
Define:
F1 : Futures price at time hedge
is set up
F2 : Futures price at time asset is
sold
S2 : Asset price at time of sale
b2 : Basis at time of sale
Price of asset S2
Gain on Futures F1 −F2
Net amount received S2 + (F1 −F2) =F1 + b2
Cost of asset S2
Gain on Futures F2 −F1
Net amount paid S2 − (F2 −F1) =F1 + b2
27. Next SlideNiraj Thapa
Arguments In Hedging
IN FAVOR
• Companies should focus on the
main business they are in and
take steps to minimize risks
arising from interest rates,
exchange rates, and other
market variables
AGAINST
• Shareholders are usually well
diversified and can make their
own hedging decisions
• It may increase risk to hedge
when competitors do not
• Explaining a situation where
there is a loss on the hedge and
a gain on the underlying can be
difficult
28. Next SlideNiraj Thapa
Basis Risk
• Generally, it is the spot price minus the futures price
• Basis risk arises because of the uncertainty about the basis when the hedge is closed out.
• Instances:
The asset whose price is to be hedged may not be exactly the same as the asset
underlying the futures contract.
The hedger may be uncertain as to the exact date when the asset will be bought or sold.
The hedge may require the futures contract to be closed out well before its expiration
date.
The basis would be zero if the asset to be hedged and the asset underlying the futures
contract are the same at expiration of the contract
The hedge ratio is the ratio of the size of the position taken in futures contracts to the size of
the exposure
29. Next SlideNiraj Thapa
It is a contract
giving its owner the right to buy or sell an asset
at a fixed price
on or before a given date.
Traded both on exchanges and in the over-the-counter market
DEFINITION
Note: Any option will be exercised if the buyer gets advantages
FEATURES Options
30. Next SlideNiraj Thapa
gives the holder the right
to sell the underlying asset by
a certain date for a certain price
gives the holder the right
to buy the underlying asset
by a certain date
for a certain price.
CALL
OPTION
American options European Options
can be exercised at any time exercised only on the expiration date
before the expiration date
(Problem in pricing-
so banned in India)
PUTOPTION
EXERCISE
STYLES
32. Next SlideNiraj Thapa
Summary of the Determinants of Option Value
If the value of the underlying asset < Strike Price– Buyer does not exercise (CALL OPTION)
If the value of the underlying asset > Strike Price – Buyer does not exercise (PUT OPTION)
Factor Put Value Call Value
Increase in Stock Price Increases Decreases
Increase in Strike Price Decreases Increases
Increase in variance of underlying asset Increases Increases
Increase in time to expiration Increases Increases
Increase in interest rates Increases Decreases
Increase in dividends paid Decreases Increases
33. Next SlideNiraj Thapa
Basics
1) Option seller sells the right and option buyer buys the right.
2) Call or Put should always be talked w.r.t. the underlying.
3) The party having the obligation shall pay security margin (Initial Margin)
4) There is an underlying stock or index
5) There is an expiration date of the option
6) There is a strike price of the option
34. Next SlideNiraj Thapa
Option Positions
Options trader buy call options with the belief that the price of the
underlying security will rise significantly beyond the strike price
before the option expiration date
Investor buy put options with the belief that the price of
the underlying security will go significantly below the striking price
before the expiration date
Option trader sells the option in the hope that they expire
worthless so that they can pocket the premiums.
The converse strategy to the long put.
Involves the selling of put options.
Commonly known as put writing.
LONG CALL
LONG PUT
SHORT CALL
SHORT PUT
35. Next SlideNiraj Thapa
Diagrammatic Examples (Call Option)
SBI Option
(Seller)
Mr. A
SBI Option
(Buyer)
Mr. B
Enters into an agreement & Sells “Right”
Mr. A’s Right NO
Mr. A’s Obligation YES
Mr. B’s Right YES
Mr. B’s Obligation NO
Mr. B Pays the option
Premium
Mr. A received the option
Premium
He has the obligation to deliver
the Underlying if the option is
exercised by B
He has the right to buy/take
delivery of the Underlying
Short in Option
& Underlying
Long in Option &
Underlying
36. Next SlideNiraj Thapa
Diagrammatic Examples (Put Option)
SBI Put Option
(Seller)
Mr. A
SBI Put Option
(Buyer)
Mr. B
Enters into an agreement & writes “Put Option”
Mr. A’s Right NO
Mr. A’s Obligation YES
Mr. B’s Right YES
Mr. B’s Obligation NO
Mr. B Pays the Put Option
Premium
Mr. A received the Put
Option Premium
He has the obligation to
deliver the Underlying if the
option is exercised by B
He has the right to buy/take
delivery of the Underlying
Short in Put Option
Long in Underlying
(If option is exercised by Mr. B)
Long in Option
Short in Underlying
(He has to deliver the underlying)
37. Next SlideNiraj Thapa
Some Terminologies
Strike Price
Price at which the underlying
asset is to be bought or sold
when the option is
exercised.
It's relation to the market
value of the underlying asset
affects the moneyness of
the option and is a major
determinant of the option's
premium.
Premium
Simply, price for the right
depends on the strike price,
volatility of the underlying, as well
as the time remaining to
expiration.
Expiration Date
Once the stock option expires, the
right to exercise no longer exists and
the stock option becomes worthless.
The expiration month is specified for
each option contract.
The specific date on which expiration
occurs depends on the type of
option.
Contract Multiplier
states the quantity of the underlying
asset that needs to be delivered in
the event the option is exercised.
For stock options, each contract
covers 100 shares.
Spot Price
The current price at
which a particular
security can be bought or
sold at a specified time
and place
The price in the contract
is known as the exercise
price or strike price
The date in the contract is known
as the expiration date or maturity.
The act of buying or
selling the underlying
asset via the option
contract is referred to
as exercising the
option.
38. Next SlideNiraj Thapa
Cash Flows & Profits
In the Hands of Option Buyer
Expiry Date
NIL Inflow
In the Hands of Option Writer
Expiry Date
Outflow NIL
Option
Exercise
Option Not
Exercised
Option
Not
Exercised
Option
Exercised
Remember: Always at Inception of the agreement buyer has outflow and seller has inflow
39. Next SlideNiraj Thapa
Quantifying The Amounts
PUT OPTION CALL OPTION
BUYER SELLER BUYER SELLER
If X > S Inflow (X-S) Outflow (S-X) 0 0
Option NOT Exercised
If X < S 0 0 Inflow (S-X) Outflow (X-S)
Option NOT Exercised
Note: Say X means Strike Price & S means Spot Price
40. Next SlideNiraj Thapa
Profit Or Loss- (Premium To Be Adjusted With The Cash Flows)
PUT OPTION CALL OPTION
Case I: BUYER SELLER BUYER SELLER
If X > S Inflow (X-S) Outflow (S-X) 0 0
(Option NOT Exrcised)
Premium (P) P (P) P
Profit (Loss) X-S-P S-X-P (P) P
Conclusion Limited Profit Limited Loss To the extent of Premium
Case II:
If X < S 0 0 Inflow (S-X) Outflow (X-S)
(Option NOT Exrcised)
Premium (P) P (P) P
Profit (Loss) S-X-P X-S+P
Conclusion To the extent of Premium Unlimited Profit Unlimited Loss
41. Next SlideNiraj Thapa
OPTION PRICE = INTRINSIC VALUE + TIME VALUE
(OPTION PREMIUM) (EXTRINSIC VALUE)
Computed by
Comparing Spot
Price & Strike Price
Keeps on Changing
due to change in
Spot Price
Quoted Price
[Determined by
using Theoretical
Price]
Bal. Fig
42. Next SlideNiraj Thapa
In Case of Call Option
Example: IDFC Spot Price at time “t” = 120
IDFC Call Option Strike Price = 110 [Right to buy]
IDFC Call Option Price (premium) = 15
Now, Intrinsic Value = Spot Price – Strike Price
120-110 =10 (Portion of profit already made)
Time Value = 15-10 = 5 (Profit yet to be made).
Break Even Spot Price at Expiry: Strike Price + Premium
= 110 + 15 = 125
43. Next SlideNiraj Thapa
In Case of Put Option
Example: IDFC Spot Price at time “t” = 120
IDFC Call Option Strike Price = 135 [Right to Sell]
IDFC Call Option Price (premium) = 20
Intrinsic Value: Strike Price –Spot Price
= 135-120 = 15
Extrinsic Value = 20-15 = 5
Break Even Spot Price at Expiry: Strike Price – Premium Paid
= 135 -20 = 115
Note: In theory time value declines at a constant rate while in practice the decline rate would be
faster nearer the expiry date
44. MONEYNESS OF OPTION
ITM OTM
(IN THE MONEY) (OUT OF THE MONEY)
ITM OPTIONS ARE
EXPENSIVE SINCE
IV ARE HIGH
NIL INTRINSIC
VALUE
X < S
It describes the relationship between the strike price of an option and the current trading price of its underlying security.
ATM
(AT THE MONEY)
IV = 0
X > SS = X
X > S S > XS = X
CALL OPTION
PUT OPTION
46. Next SlideNiraj Thapa
OPTION STRATEGIES
Option Strategies
One Instrument Strategies More than one instrument Strategies
i) Long Call Spread Combinations
ii) Short Call i) Bull i) Straddle
iii) Long Put Put
iv) Short Put Call ii) Strip
v) Married Put ii) Bear iii) Strap
vi) Protective Put Put
vii) Covered Call Call iv) Strangle
iii) Butterfly Spread
Put
Call
iv) Calender Spread
47. Next SlideNiraj Thapa
ONE INSTRUMENT STRATEGIES
Long Call
View: Bullish
BE Spot Price: S = [X+C]
Profit: Rise in Price
Profit at expiry: When S > BEP
Profit S – [X+C]
Max. Profit Unlimited
Maximum Loss: C [The Premium]
Belief that the price of the underlying security will rise significantly beyond the strike price before the option expiration date
48. Next SlideNiraj Thapa
Short Call
View: Bearish
Profit: Fall in Price
BE Spot Price: S = [X+C]
Profit at expiry: When [S<BEP]
Profit [X+C] – S
Max. Profit C
Maximum Loss: Unlimited
[If price exceeds BEP]
Belief that stock price falls below the strike price of the call options by expiration
49. Next SlideNiraj Thapa
Long Put
View: Bearish
Profit: Fall In Price
BE Spot Price: X - C
Profit at expiry: When S<BEP
Profit X- [C+S]
Max. Profit X - C
Maximum Loss: Premium
Belief that the price of the underlying security will go significantly below the striking price before the expiration date
50. Next SlideNiraj Thapa
Short Put
View: Bullish
Profit: If Price Rises
BE Spot Price: S = [X-C]
Profit at expiry: When S > BEP
Profit S- [X-C]
Max. Profit C
Maximum Loss: [X – P]
Belief that the price of the underlying security will rise significantly beyond the strike price before the option expiration date
51. Next SlideNiraj Thapa
Married Put
View: Bullish
BEP: [X+C]=Price of Stock
Profit: S>Purchase Price of Stock +C
Maximum Profit: Unlimited
Belief that the stock price will fall and you want to protect the profits made from a stock, buying a put option will
mitigate such loss.
Buy one Stock at S,
Buy Put Option at X and S=X
52. Next SlideNiraj Thapa
Protective Put
View: Bullish
BEP: [X+C] = Price of Stock
Profit: Price of Stock> [X+P]
Maximum Profit: Unlimited
The holder buys the stock at first and later on he will buy the put option
Used as a means to protect unrealized gains on shares from a previous purchase
53. Next SlideNiraj Thapa
Covered Call
In the Money Covered Call
• Max Profit = Premium Received -
Purchase Price of
Underlying + Strike Price
of Short Call
• Max Profit Achieved :When Price of
Underlying >=
Strike Price of Short Call
BEP = Purchase Price of Underlying -
Premium Received
Call options are written against a holding of the underlying security
Earn a premium writing calls while at the same time appreciate all benefits of underlying stock ownership
A short position in a call option on an asset combined with a long position in the asset
Far less risky than naked calls
54. Next SlideNiraj Thapa
Created by the simultaneous purchase and sale of options of the same class on
the same underlying security and same expiration dates but with
different strike prices.
Spread Constructed using CALLS-Call Spread
Spread Constructed using PUT- Put Spread
Spread designed to earn profit from a rise in price - bull spread
Spread designed to earn profit from a fall in price - bear spread
MORE THAN ONE INSTRUMENT STRATEGIES
Spread
55. Next SlideNiraj Thapa
Note 1) A higher strike price call option would be less costlier as
compared to lower strike price call option.
Note 2) A higher strike price put option would be more costlier
as compared to lower strike price put option.
Note 3) Maximum loss is fixed for Net Payer of Premium
Maximum gain is fixed for Net Receiver of Premium
Some Concepts in Spread
56. Next SlideNiraj Thapa
Bull Call Spread:
Strategy:
Sell high strike price call option
& simultaneously, buy low strike price call option
Gain: When price of stock rises above
higher strike price .
57. Next SlideNiraj Thapa
Say we have two call options:
Low Strike Price Call Option be X1
Higher Strike Price Call Option be X2
C1 & C2be the Premium paid on X1 & X2 resp. where C1>C2
Move as per strategy and view the cases
Case I Case II Case III
Spot Price at
Expiry <X1
Spot Price at Expiry falls
between X1 & X2
Spot Price at Expiry
goes above X2
X1 Call Option Worth Less S-X1 S-X1
X2 Call Option Worthless Worth Less X2-S
Net Premium -C1+C2 -C1+C2 -C1+C2
Maximum Profit (Loss) C1+C2 (S-X1)-C1+C2 (X2-X1) -C1+C2
Net Payer of Premium
58. Next SlideNiraj Thapa
Bull Put Spread:
Strategy: Sell high strike price put
option & simultaneously, buy
low strike price put option
59. Next SlideNiraj Thapa
Say we have two put options:
Low Strike Price Put Option be X1
Higher Strike Price Put Option be X2
P1 & P2 be the Premium paid on X1 & X2 resp. where P2>P1
Move as per strategy and view the cases
Case I Case II Case II
Spot Price at Expiry <X1 Spot Price at Expiry falls
between X1 & X2
Spot Price at Expiry goes
above X2
X1 Put Option (X1-S) Worth Less Worth Less
X2 Put Option (S-X2) (S-X2) Worth Less
Net Premium -P1+P2 -P1+P2 -P1+P2
Maximum Gain (Loss) (X1-X2) - P1+P2 (S-X2) - P1+P2 -P1+P2
Net Receiver of Premium
61. Next SlideNiraj Thapa
Say we have two Call options:
Low Strike Price Call Option be X1
Higher Strike Price Call Option be X2
C1 & C2 be the Premium paid on X1 & X2 resp. where C1>C2
Move as per strategy and view the cases
Case I Case II Case II
Spot Price at
Expiry <X1
Spot Price at Expiry falls
between X1 & X2
Spot Price at Expiry goes
above X2
X1 Call Option Worthless X1-S X1-S
X2 Call Option Worthless Worth Less S-X2
Net Premium C1-C2 C1-C2 C1-C2
Maximum Gain (Loss) C1-C2 (X1-S)+(C1-C2) (X1-X2) +(C1-C2)
Net Receiver of Premium
62. Next SlideNiraj Thapa
Bear Put Spread
Strategy:
Sell lower strike price Put option &
simultaneously buy higher strike price put
option.
63. Next SlideNiraj Thapa
Net Payer of Premium
Say we have two put options:
Low Strike Price Put Option be X1
Higher Strike Price Put Option be X2
P1 & P2 be the Premium paid on X1 & X2 resp. where P1<P2
Move as per strategy and view the cases
Case I Case II Case II
Spot Price at Expiry <X1 Spot Price at Expiry falls
between X1 & X2
Spot Price at Expiry goes
above X2
X1 Put Option (S-X1) Worth Less Worth Less
X2 Put Option (X2-S) (X2-S) Worth Less
Net Premium P1-P2 P1-P2 P1-P2
Maximum Gain (Loss) (X2-X1) + (P1-P2) (X2-S) + (P1-P2) (P1-P2)
64. Next SlideNiraj Thapa
Butterfly Spread
Involves positions in options with three different strike prices
Created by:
-buying a call option with a relatively low strike price, X1;
-buying a call option with a relatively high strike price, X3; and
selling two call options with a strike price, X2
Buy
1
Call
Sell
Two
Calls
Buy
1
Call
X1=95 (say) X2 = 100 X3 = 105
C1= -10 (say) 2xC2 = 2x7 C3 = -5
X1<X2<X3
X2-X1 = X3-X2
C1>C2>C3
(I) (II) (III) (IV)
65. Next SlideNiraj Thapa
BUTTERFLY SPREAD
BUTTERFLY CALL
SPREAD
BUTTERFLY PUT
SPREAD
LONG BUTTERFLY
CALL SPREAD
SHORT BUTTERFLY
PUT SPREAD
SHORT BUTTERFLY
CALL SPREAD
LONG BUTTERFLY
OUT SPREAD
66. Next SlideNiraj Thapa
Case I Case II Case III Case IV
Conditions Spot Price at Expiry <X1 Spot Price at Expiry falls
between X1 & X2
Spot Price at Expiry falls
between X2 & X3
Spot Price at Expiry goes
above X3
X1 Call Option 0 S-X1 S-X1 S-X1
X2 Call Option 0 0 2(X2-S) 2(X2-S)
X3 Call Option 0 0 0 S-X3
Net Premium (2C2-C1-C3) =-1 (2C2-C1-C3) =-1 (2C2-C1-C3) =-1 (2C2-C1-C3) =-1
Maximum Gain (Loss) -1 (S-X1-1) (S-X1) -2(S-X2)-1 -1
Note: Profit will be maximum when S is equal to X
67. Next SlideNiraj Thapa
COMBINATIONS
STRADDLE STRANGLE STRAPSTRIP
LONG
STRADDLE
SHORT
STRANGLE
SHORT
STRADDLE
LONG
STRANGLE
LONG STRADDLE
+
LONG PUT
LONG STRADDLE
+
LONG CALL
68. Next SlideNiraj Thapa
STRADDLE
• LONG STRADDLE
Strategy:
Buy a call and a put both having
-same underlying
-same expiry date
-same strike price
View: Large movement in price
either way.
• SHORT STRADDLE
Strategy:
Sell a call and put both having
-same underlying
-same expiry date
-same strike price
View: No (or little) movement in
price.
69. Next SlideNiraj Thapa
STRANGLE
• LONG STRANGLE
Strategy:
Buy one call and put
-having same underlying
-having same expiry date
-but different strike price
View: Very large movement in price
• SHORT STRANGLE
Strategy:
Sell one call and put
-having same underlying
-having same expiry date
-but different strike price
View: No large movement in price
70. Next SlideNiraj Thapa
• STRIP
Strategy:
Buy 2 Puts and 1 call having
-same underlying
-same expiry date
-same strike price
• STRAP
Strategy:
Buy 2 Calls and 1 put having
-same underlying
-same expiry date
-same strike price
71. Next SlideNiraj Thapa
Future Pricing
Cost of Carry Model
-states futures price should
depend upon two things:
• The current spot price.
• The cost of carrying or storing the
underlying good from now until
the futures contract matures.
F = S + C
Assumptions:
• There are no transaction costs or
margin requirements.
• There are no restrictions on short
selling.
• Investors can borrow and lend at
the same rate of interest
Simply, it is the theoretical value of a future contract
72. Next SlideNiraj Thapa
F = S+C
F = S + [Sxr%xT/12]
F = S [1+(r%xT/12)]
Hence, future price is the compounded
value of the underlying price at risk free
rate over the contract life.
Alternatively,
F = S x ert
Where,
ert means continuous compounding.
Note: Both formulae will give same result if value of ert is taken upto one factor.
73. Next SlideNiraj Thapa
Pricing of Dividend Paying Stock
DIVIDEND
PAID
CONTINUOUSLYPAID IN LUMP SUM
Note: Income would reduce cost of Strategy while expense will increase the same.
74. Next SlideNiraj Thapa
Paid in lump sum
Option 1:
Step I: Adjusted “S”
= S-PV of all dividends
Step II:
F = Adj.S x [1+(r%xT/12)]
F = Adj.S x ert
Option 2:
F = S x [1+(r%xT/12)]-Compounded
value of dividend
expected to be
received on expiry
date.
Paid Continuously:
Option 1:
F = S [1+(r%-y%)xT/12]
F = S x e(r%-y%)T
75. Next SlideNiraj Thapa
Creating a replicating portfolio:
Objective: use a combination of risk free borrowing/lending and
the underlying asset to create the same cashflows as
the option being valued.
Call = Borrowing + Buying Δ of the Underlying Stock
Put = Selling Short Δ on Underlying Asset + Lending.
The number of shares bought or sold is called the option delta.
The principles of arbitrage then apply, and the value of the option has to
be equal to the value of the replicating portfolio.
Option Pricing
77. Next SlideNiraj Thapa
The version of the model presented by Black and Scholes was
designed to value European options, which were dividend-
protected.
The value of a call option in the Black-Scholes model can be written
as a function of the following variables:
S = Current value of the underlying asset
X = Strike price of the option
t = Life to expiration of the option
r = Riskless interest rate corresponding to the life of the option
s2 = Variance in the ln (value) of the underlying asset
Black Scholes Model
78. Next SlideNiraj Thapa
The current stock price
The strike price
The time to expiration
The volatility of the stock price
The risk-free interest rate
The dividends expected during the life of the
option
Factors Affecting Option Prices
79. Next SlideNiraj Thapa
• Value of call = S N (d1) - K e-rt N(d2)
Where,
d2 = d1 - s t
The replicating portfolio is embedded in the Black-Scholes model. Toreplicate
this call, you would need to
• Buy N(d1) shares of stock; N(d1) is called the option delta
• Borrow K e-rt N(d2)
80. Next SlideNiraj Thapa
Meaning:
N(d1)
Equal to Δ of replicating
portfolio method. It means no.
of units of underlying.
Statistical
Area from Z= - ∞ to Z= d1
Meaning:
N(d2)
Prob. That option will be
exercised at expiry.
Statistical
Area form Z =- ∞ to Z = d2
81. Next SlideNiraj Thapa
Adjusting for Dividends
• Paid in Yield form
If the dividend yield (y = dividends/ Current
value of the asset) of the underlying asset is
expected to remain unchanged during the
life of the option, the Black-Scholes model
can be modified to take dividends into
account.
C = S e-yt N(d1) - X e-rt N(d2)
d2 = d1 - s t
The value of a put can also be derived:
P = K e-rt [1-N(d2)] - S e-yt [1-N(d1)]
• Paid in Lump Sum
Concept of Adjusted “S”
= S – PV of all dividends
during option life.
Now, use BSM method as if there is no
dividend
82. Next SlideNiraj Thapa
Most practitioners who use option pricing models to value real options
argue for the binomial model over the Black-Scholes and justify this
choice by noting that
• Early exercise is the rule rather than the exception with real options
• Underlying asset values are generally discontinuous.
If you can develop a binomial tree with outcomes at each node, it looks
a great deal like a decision tree from capital budgeting. The question
then becomes when and why the two approaches yield different
estimates of value.
Choice of Option Pricing Models
83. Next SlideNiraj Thapa
Swaps Contracts
• Arrangements to exchange cash flows over time.
• Provides a means to hedge a stream of risky payments.
• One party makes a payment to the other
depending upon
whether a price turns out to be greater or less
than a reference price
that is specified in the swap contract.
• Two basic types - interest-rate swaps or currency swaps.
84. Next SlideNiraj Thapa
Interest-Rate Swaps
• Agreement to exchange a
floating-rate payment for a fixed-
rate payment or vice versa.
• Use:
Used to modify interest rate
exposure.
transform a floating-rate
loan into a fixed-rate loan,
or vice versa. transform a
floating-rate investment to a
fixed- rate investment, or
vice versa.
• For example, in an interest rate swap, the
exchangers gain access to interest rates available
only to the other exchanger by swapping them.
In this case, the two legs of the swap are a fixed
interest rate, say 3.5%, and a floating interest rate,
say LIBOR + 0.5%. In such a swap, the only things
traded are the two interest rates, which are
calculated over a notional value. Each party pays the
other at set intervals over the life of the swap. For
example, one party may agree to pay the other a
3.5% interest rate calculated over a notional value of
$1 million, while the second party may agree to pay
LIBOR + 0.5% over the same notional value. It is
important to note that the notional amount is
arbitrary and is not actually traded.
The London Interbank Offered Rate (LIBOR) is the rate most international
banks charge one another for overnight Eurodollar loans.
85. Next SlideNiraj Thapa
Currency Swaps
agreements to deliver one currency in exchange for another.
one party agrees to pay interest on a principal amount in one currency &
in return, it receives interest on a principal amount in another currency.
Principal amounts are not usually exchanged in an interest rate swap.
Here principal amounts are usually exchanged at both the beginning and
the end of the life of the swap.
For a party paying interest in the foreign currency, the foreign principal is
received, and the domestic principal is paid at the beginning of the life of
the swap. At the end of the life of the swap, the foreign principal is paid
and the domestic principal is received.
• Use: -transform a loan in one currency into a loan in another currency.
transform an investment denominated in one currency into an
investment denominated in another currency.
86. Next SlideNiraj Thapa
Why To Use Derivatives?
• Risk management:
Eg. The farmer-a seller of com-enters into a contract which makes a payment when -the price of corn is low. This
contract reduces the risk of loss for the farmer, who we therefore say is hedging. It is common to think of
derivatives· as forbiddingly complex, but many derivatives are simple and familiar.
• Speculation-serve as investment vehicles
Eg. if you want to bet that the S&P 500 stock index will be between 1 300 and 1 400 one year from today,
derivatives can be constructed to let you do that.
• Reduced transaction costs
Eg. The manager of a mutual fund may wish to sell stocks and buy bonds for this he has to pay fees to broker
which is costly while it is possible to trade derivatives instead and achieve the same economic effect as if stocks
had actually been sold and replaced by bonds
• Regulatory arbitrage
It is sometimes possible to circumvent regulatory restrictions, taxes, and accounting rules by trading derivatives.
Derivatives are often used, for example, to achieve the economic sale of stock (receive cash and eliminate the
risk of holding the stock) while still maintaining physical possession of the stock. This transaction may allow the
owner to defer taxes on the sale of the stock, or retain voting rights, without the risk of holding the stock.
• To change the nature of a liability
• To lock in an arbitrage profit
• To change the nature of an investment without incurring the costs of selling one portfolio and buying another.
87. Next SlideNiraj Thapa
Users of Derivatives
• Market-Maker:
Market-makers are intermediaries, traders who will buy derivatives from customers
who wish to sell, and sell derivatives to customers who wish to buy. Generally,
market-makers are like grocers who buy at the low wholesale price and sell at the
higher retail price. Market-makers typically hedge this risk and thus are deeply
concerned about the mathematical details of pricing and hedging.
• Economic observer:
They try to make sense of everything (like the logic of the pricing models)
• Arbitrageurs
Arbitrage involves locking in a riskless profit by simultaneously entering into
transactions in two or more markets.
88. Next SlideNiraj Thapa
Dark Side of Derivatives
Six examples will be used to illustrate some of the perils, especially ethical
perils, in use of financial derivatives:
• Equity Funding Corporation of America (1973)
• Baring Bank (1994)
• Orange County, California (1994)
• Long Term Capital Management (1998)
• Enron (2001)
• Global Crossing
• Each of them represented an effort to use financial derivatives to produce
inflated returns. Two cases were proven to be frauds. Two appear to have
been innocent of fraud. Two are still to be seen.
• Each was a major financial catastrophe, affecting not only those directly
involved but the world at large.
89. • “I view derivatives as time bombs, both for the parties that deal in them and the
economic system”-Warren Buffett
• It is quite complex and various strategies of derivatives can be implemented only by an
expert and therefore for a layman it is difficult to use this and therefore it limits its
usefulness.
• When company failure on derivative markets, shareholders, creditors and other relevant
parties tend to be lose their confidence in the company’s performance, therefore, it will
face a much worse financial position. Shareholders may start to sell their stocks, and
creditors may ask for early repayment of credit. Under these circumstances, the
reputation of company may be seriously damaged.
• Derivatives instrument can be profitable for investors if investors are able to time the
markets. A mistake in accurately predicting the market can lead to substantial loss.
• Finance experts often express that traders can switch from being hedgers to speculators
or from being arbitrageurs to speculators.
• Further derivatives are complex segments.
90. Feed back & suggestions are welcome at
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