1_DERIVATIVES GÇô MARKET & INSTRUMENTS

8/6/2019 1_DERIVATIVES GÇô MARKET & INSTRUMENTS

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Malhar Majumder

DERIVATIVES ² MARKETS &INSTRUMENTS



Learning obj ectives:

6/15/2011Malhar Majumder2

y a. define a derivative and differentiate between exchange-traded and over-the counter derivatives;

y b. define a forward commitment and a contingent claim, and

describe the basic characteristics of forward contracts,futures contracts, options (calls and puts), and swaps;y c. discuss the purposes and criticisms of derivative markets;y d . explain arbitrage and the role it plays in determining

prices and promoting market efficiency.



Wh at is d erivative?

y A security that derives itsvalue from the value or returnof ano ther asset

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C ateg o ries of d erivative contract

y F orwardy F uturesy Swapsy Options




O ver th e C ou nter an d Ex ch ange tra d e dd erivatives

(Custom and OTC) Exchange Traded

Forward Futures

Swaps Options




F o rwar d comm itm ent

y L egally binding promise to perform some action in future




F o rwar dy One party agrees to buy and the counterparty agrees to sell a

security or physical asset at a specific price on a specific datein future.




Fu tu re y forward contract that isstan dardized and exch ang e

tr adedy Active sec on dary m arkety

Regu latedy Novati ony MTM




Swapy one party agrees to pay the short-term (floating) rate of

interest on some principal amount, and the counterpartyagrees to pay a certain (fixed) rate of interest in return




C ateg o ries of o pti ony call op tion

y Seller (writer) , buyer (h older)

y

put op ti ony Seller (writer) , buyer (h older)




C ontingent clai m

y Options are contingent claims




Bene f its an d criticis m of d erivative m arkety T he benefits:

y Provide price informationy Allows risk to be managed and shifted among market playersy

Reduce the cost of transaction

y T he criticism:y High risky

Complexy Highly leveragedy Resemble gambling

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Arb itrage & o pti on m arkety L aw of one pricey 2 or more securities with uncertain return may be combined

to generate a certain level of payoff






Qu iz « C ontin u e dA swap isA. highly regulatedB. a series of option contractC. a series of forward contractD. the exchange of one asset for

another

T he call option gives the holder:A. the right to sell at a specific

priceB. the right to buy at a specific

priceC. the obligation to buy at aspecific price

D. the obligation to sell at aspecific price

Arbitrage preventsA. risk managementB. market efficiencyC. profit higher than risk free rate

of return

D. two assets with identical payoffsfrom selling at different pricesDerivative can provide orimprove all of the followingexce p t :A. liquidityB.

risk reductionC. price informationD. inflation reduction


1_DERIVATIVES GÇô MARKET & INSTRUMENTS

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