Derivatives. cmi
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This document discusses derivative instruments such as futures and forwards. It defines derivatives as instruments whose value is derived from an underlying security such as a stock, commodity, currency, or index. Future contracts obligate the buyer and seller to transact at a predetermined price on a future date, while forward contracts are similar but not standardized. Reasons for using derivatives include hedging against volatility and speculation. Key concepts discussed include short selling, holding long positions, and offsetting forward contracts before expiration to realize gains or losses.
Derivatives. cmi
- 1. Derivative Instruments- Future, Forward Presented By Ganesha.CK
- 2. Contents Introduction What is Derivatives Features of Derivative Instruments Participants in Derivative market Reasons to use Derivatives Concepts to understand Future contract, Features Forward contract, Features Payoff, Offsetting,
- 3. Introduction In the financial marketplace some instruments are regarded as fundamentals, while others are regarded as derivatives. Financial Marketplace Derivatives Fundamentals
- 4. Introduction (II) Financial Marketplace Derivatives Fundamentals • Futures • Stocks • Forwards • Bonds • Options • Etc. • Swaps
- 5. What is a Derivative? (I) Options The value of the derivative instrument is Futures DERIVED from the Forwards underlying security Swaps Underlying instrument such as a commodity, a stock, a stock index, an exchange rate, a bond, another derivative etc..
- 6. What is a Derivative? (II) Futures The owner of a future has the OBLIGATION to sell or buy something in the future at a predetermined price. The owner of a forward has the OBLIGATION to sell or buy Forwards something in the future at a predetermined price. The difference to a future contract is that forwards are not standardized. Options The owner of an options has the OPTION to buy or sell something at a predetermined price and is therefore more costly than a futures contract. Swaps A swap is an agreement between two parties to exchange a sequence of cash flows.
- 7. Features of Derivative Instrument A Derivative instruments relates to the future contract between two parties. Derivative instruments have the value (Derived from underlying assets ) The counter parties have specified obligation under derivative control. (all contracts are different) The size of the derivative depends upon its notional amount. Derivatives are also called deferred delivery or deferred payment instrument. ( short and long position)
- 8. Participants in Derivative Market The participants in the derivative markets an be Banks, FIIs, Corporate, Brokers. Etc… He is a person who undertakes a position in future 1.Hedgers and other markets for purpose of reducing exposure to one or more types of risk. Speculators are operators who are willing to 2.Speculators take a risk by taking future position with the expectation to earn profits. They are the operators who deal in different 3.Arbitrageurs markets simultaneously for profit and eradicate the mispricing of securities across different markets. He is a person who believes in lower expected 4.Spreaders return at the reduced risk .
- 9. Reasons to use derivatives (I) Derivative markets have attained an overwhelming popularity for a variety of reasons... Hedging: • Interest rate volatility • Stock price volatility • Exchage rate volatility • Commodity prices volatility VOLATILITY Speculation: • High portion of leverage • Huge returns EXTREMELY RISKY
- 10. Reasons to use Derivatives (II) Also derivatives create... • a complete market, defined as a market in which all identifiable payoffs can be obtained by trading the securities available in the market. • and market efficiency, characterized by low transaction costs and greater liquidity.
- 11. Concepts to Understand Short Selling: • Short selling is the selling of a security that the seller does not own. • Short sellers assume the risk that they will be able to buy the stock at a more favorable price than the price at which they sold short. Holding Long Position: • Investors are legally owning a security. • Investors are the legal owners of a security.
- 12. Future Contracts (I) The owner of a future contract has the Futures OBLIGATION to sell or buy something in the future at a predetermined price.(Ex Former) 1.Commodity futures - underlying asset is a commodity 2.Financial futures - underlying is asset Types • Interest rate future: Treasury bills, notes, bonds, debenture etc.. • Foreign currency future: • Stock index future: • Bond index future:
- 13. Features of Future contract
- 14. Forward Contracts (II) Forwards The owner of a forward has the OBLIGATION to sell or buy something in the future at a predetermined price. The difference to a future contract is that forwards are not standardized. A Forward Contract underlies the same principles as a future contract, besides the aspect of non-standardization. Example: x enter into contact on 1st October 2005 To buy 50 shares at Rs 1000 on 1st December 2005 from y x has to pay 50000 on 1st December 2005
- 15. Features of Forward contracts they are bilateral contract – counter risk they are unique in terms of size, expiration date, asset size of both parties. It specifies future date of delivery and payment. It obligates the buyer and seller to delivery of assets. It specifies the price which determined presently is to be paid in future
- 16. Payoff from forward contract To explain profit and loss (payoff) on a forward contract What is Offsetting the Forward contract? In forward contract the party bears the risk until the contracts expire because profit to be incurred will depend upon the future spot price of the underlying assets
- 17. THANK YOU ALL