Derivativ es Group 4 Teacher: Ms. Bui Thi Kim Phuc
Aug 23, 2014
Derivatives Group 4 Teacher: Ms. Bui Thi Kim Phuc
OVERVIEW
1. Future – Dung Do
2. Forward – Loan Dang
3. Hedging and Speculation – Truc Mai Nguyen
4. Option (Call) – Sam Hoang
5. Option (Put) – Phuong Mai Pham
6. Warrants – Hang Nga Nguyen
7. Swap – Ngoc Huyen Nguyen
1. FUTURES
Definition
Types
When to apply
Strengths & Weaknesses
FUTURES Definition
Contracts to buy or sell fixed quantities of a commodity, currency, or financial assest at a future date, at a price fixed at the time of making contract.
FUTURES Types
Commodities futures
•Metals•Energy•Grains & Oil Seeds•Livestocks•Food & Fiber
Financial futures
•Eurodollar Futures•U.S. Treasury Futures•Foreign Government Debt Futures•Swap Futures•Forex Futures•Single Stocck Futures•Index Futures
FUTURES When to appy
Example:(clip)
FUTURES When to appy
Three Main Uses: • Capital Appreciation• Leverage• Hedge Against Risk
FUTURES Strengths & Weaknesses
Strengths • Futures are extremely useful in reducing unwanted risk.• Futures markets are very active, so liquidating your contracts is usually easy.
FUTURES Strengths & Weaknesses
Weaknesses· Being considered one of the riskiest investments in the financial markets - they are for professionals only.· In volatile markets - very easy to lose your original investment.· The very high amount of leverage can create enormous capital gains and losses, you must be fully aware of any tax consequences
FUTURES Conclusion
There are several ways to participate in the futures market. All of them involve risk - some more than others. You can trade your own account, have a managed account or join a commodity pool.
2. FORWARD
Definition
Distinct feature
Function
Case
FORWARD Definition
A contract between two parties to buy or sell an asset
at a specified future time at a price agreed upon today.
THE SELLER THE BUYER
Future real transaction
Today’s price
FORWARD Case
FARMER A
FORWARD Distinct feature
Non- standardized
Over-the-counter
a zero-sum game
FORWARD Function
Control liquility risk
Speculation
FORWARD Activities
Game 1: FORWARD vs. FUTURE
Game 2: Vocabulary
FORWARD Activities
AFORWARD
TRANSACTION
BFUTURE
TRANSACTION
over-the-counterhighly standardizedprivately negotiated
zero counterparty risktraded in a secondary market
FORWARD VS. FUTURE
COLUMN A COLUMN B
FORWARD Activities
Words guessing
Is likely to take place in FORWARD TRANSACTION
rather than future transaction
There are 2 WORDS: first one has 12, second one has 4
LETTERS
Exists because participants may be unwilling or unable to
follow through the transaction at the time of settlement.
Appears when one party BREAKS the terms of the agreement.
This is a kind of UNCERTAINCY facing in any transaction.
FORWARD Activities
The first word is FOUR- SYLLABLE word. It is a combination of 2 COMPONENTS MEANING:
“against/ opposite” “one site in a contract”
The second word means THE POSSIBILITY OF Sth BAD HAPPENING AT SOME TIME IN THE FUTURE
COUNTERPARTY RISK
FORWARD Activities
It is a contract struck today, for the physical borrowing of funds at a
fixed future date.
The THIRD single word means LOANING.
Containing 3 single words: the FIRST and the SECOND WORDS are
exactly the same and are my topic’s name.
Used in purpose of AVOIDING RISK caused by the votality of exchange
rate.
FORWARD FORWARD BORROWING
3. HEDGING & SPECULATING
Definition1
Characteristic2
Comparison between Hedging and Speculation 3
HEDGING Definition
A method of reducing the risk of loss caused by price fluctuation
A transfer of risk without buying insurance policies
equal quantities of the same commodities
reduce risk by making a transaction in one market to protect against a loss in another
equal quantities of the same commodities
Market A Market B
HEDGING Characteristic
Who are HEDGERs ?
1. Everyone who seek to profit from price fluctuation
2. Producers, processors, and wholesalers
3. Retailers, distributors
4. Only producers
HEDGING Characteristic
reduction in RISK reduction in PROFIT
The goal of hedging is not to make money but to protect from losses.
HEDGING Characteristic
Futures Options Forwards
HEDGING TOOLS
HEDGING Example
Use futures contracts to hedge their exposure to the price of jet fuel to save a large amount of money when buying fuel as compared to rival airlines when fuel prices in the U.S. rose dramatically after the 2003 Iraq war and Hurricane Katrina
VOCABULARY GAME
(1)……………. reduce their risk by taking an opposite
position in the market to what they are trying to (2)
…………..... The ideal situation in (3)……………...
would be to cause one effect to cancel out another.
hedgershedging hedge
VOCABULARY GAME
(1)………………….has to do with short-term
expectations. When you (2)..………………, you hope
and anticipate that you will be able to make a profit
from the short-term fluctuations in price of a
particular thing. (3)……………………wants to make
money in a hurry.
a speculatorspeculate speculating
SPECULATION Definition
The activity of buying shares,
property, goods, etc. in the hope
of making a profit by selling
them at a higher price
With the risk of losing money
Comparison between HEDGING and SPECULATION
HEDGING
Risk averseTo protect from
losses
SPECULATION Characteristic
Take advantage of an expected
price movement
Extremely risky
Cause harm to other market participants
???
Now
12/2013
Mark
Phil
100 shares of
Apple Corp.
(427$/share)
What type of derivatives should Mark choose?
C A L L O P T I O N
4. CALL OPTION
Definition
How call option works and how to use call option
Game & Conclusion
1 FREE ICE CREAM
SCOOP OF
HAAGEN-DAZS
Mark
Phil
100 shares of
Apple Corp.
(425$/share)
Buy the call option at 1$
100 call
option
Apple
shares at
425$
5$
430$/share
425$/share
Profit = [430-(425+1)]*100
= 400$
2 months later
EXERCISE THE OPTION
Mark
Phil
100 shares of
Apple Corp.
(425$/share)
Buy the call option at 1$
100 call
option
Apple
shares at
425$
425$/share
Loss= 1 * 100 = 100$
2 months later
5$
420$/share
In call options trading, the option holder has the (1)………, but not the (2) …………, to buy the underlying
instrument at a specified price on or before a specified date in the future.
O B L I G A T I O N
(1)
(2)
R I G H T
If Mark decides to buy or sell the underlying instrument (rather than allowing the contract to expire worthless or closing out the position), he will …..………….. the option, and make use of the right available in the contract.
E X E R C I S E
…………… is the total cost of an option?
P R E M I U M
An option that can be exercised anytime during its life ?
A M E R I C A N O P T I O N
1 FREE ICE CREAM SCOOP
OF HAAGEN-DAZS
Call Option = Buying The Right (Not Obligation)
To Buy An Underlying Asset
CALL OPTION CONCLUSION
Use When You Expect The Price Of The Stock Is Going To Rise
5. PUT OPTION
Definition
When to apply “Put option”?
Some tips to apply PUT OPTION and CALL OPTION
This kind of option is the opposite
of call option.
“This option gives the right to…..security (or a currency, or a commodity) at a certain price during a certain period of time”
PUT OPTION Definition
WHEN TO APPLY “PUT OPTION”?
PUT OPTION
A Sample Quiz:Now: a share is worth $100A’s prediction: share will be worth above $100Adversely, B’s prediction: share will be worth
below $100
PUT OPTION When to apply “PUT OPTION” ?
A sells (or writes) B a put option at $100 (strike/exercise price).
B pays A $1 as the premium of put optionB has the right to sell the share at $100
(strike/exercise price) in the future whatever the market price wil be.
A BPut option at $100
Premium of $1
PUT OPTION When to apply “PUT OPTION” ?
Scenario 1: In the futureMarket price (MP) = 130 > Strike price (SP) =100B (will/will not) exercise his put option
because if he (did not exercise/exercised) his put option, he would lose an amount of $30
(= $130-$100)Outcome: - A (earns/loses) premium of $1 in-the-money- B (earns/loses) premium of $1 out-of-the-
money
PUT OPTION When to apply “PUT OPTION” ?
• Scenario 2: in the futureMP = 90 < SP = 100B (will/will not) exercise his put option Outcome:- A (earns/loses) premium of $1, but
(earns/loses) an amount of $100 overall, A (earns/loses) $99 out-of-the-money
- B (earns/loses) premium of $1, but (earns/loses) an amount of $10 (=$100- $90) overall, B (earns/loses) $9 in-the-money
PUT OPTION When to apply “PUT OPTION” ?
Prediction: MP will INCREASE in the future
BUY the CALL option
SELL/WRITE the PUT option
Prediction: MP will DECREASE in the future
BUY the PUT option
SELL/WRITE the CALL option
PUT OPTION Some tips to apply PUT OPTION and CALL OPTION smartly?
6. WARRANT
Definition
Classification
Comparison between warrant and option
WARRANT Definition
1997
2012
WARRANT Definition
Warrant is a type of investment that gives you the right to buy shares at a fixed price on or by a particular date.
A warrant gives you the right, but not the obligation to buy (call) or sell (put) a pre-determined asset at a pre-determined price (=exercise /strike/striking price) by a pre-determined date.
OXFORD DICTIONARY
STANDARD BANK OF SOUTH AFRICA
WARRANT Classification
The warrants can be exercised at any time up to and including the date of expiry
United States - style warrants
The warrants may be exercised only on the expiry date.
European - style warrants
WARRANT Classification
At-the-money
In-the-money
Out-of-the-money
When a warrants with an exercise price is equal to the current market price of the underlying
When a warrants with the exercise price is at below the current market price of the underlying asset
When a warrants with the exercise price is at above the current market price of the underlying asset
WARRANT Comparison
Warrants Option
• Issued by private parties• Issued by a public options
exchange
• When a warrants is exercised Þ Company issues new shares of
stock Þ The number of shares increasesÞ No voting right
• Warrants’ lifetime is measured in years
• The number of shares is constant (the owner of the call option receives an existing share)
=> Voting right
• Option’s life is measured in months
7. SWAPS
Definition7.1
Purposes7.2
Types of SWAPS 7.3
Interest rate swaps7.2
SWAPS Definition
• Definition A swap is an agreement between two counterparties to exchange two streams of cash flows for a set period of time.
Purposes
Hedging Speculation Changing the character of
an asset or liability without liquidating that asset or liability.
SWAPS Types of SWAPS
Typesof
SWAPS
– Interest Rate Swap– Currency Swap– Credit Default Swap– Forward swap– Total return swap– Circus swap– Commodity swap– Asset swap– ……
• (http://www.businessanalystfaq.com/whatisswap-typesofswaps.)
SWAPS Interest Rate Swaps
Definition: • an exchange of cash flows, CFs.
• a legal arrangement between two parties to exchange specific payments.
• involving the exchange of fixed-rate payments for floating-rate payments.
EXAMPLE• Fixed-rate payer pays 5.5% every six months
• Floating-rate payer pays LIBOR every six months
• Notional Principal = $10 million
• Effective Dates are 3/1 and 9/1 for the next three years
EXAMPLE1 2 3 4 5 6
Effective Dates LIBOR Floating-Rate Fixed-Rate Net Interest Received Net Interest ReceivedPayer's Payment* Payer's Payment** by Fixed-Rate Payer by Floating-Rate Payer
Column 3 - Column 4 Column 4 - Column 33/1/Y1 0.0459/1/Y1 0.050 $225,000 $275,000 -$50,000 $50,0003/1/Y2 0.055 $250,000 $275,000 -$25,000 $25,0009/1/Y2 0.060 $275,000 $275,000 $0 $03/1/Y3 0.065 $300,000 $275,000 $25,000 -$25,0009/1/Y3 0.070 $325,000 $275,000 $50,000 -$50,0003/1/Y4 $350,000 $275,000 $75,000 -$75,000
* (LIBOR/2)($10,000,000)** (.055/2)($10,000,000)
EXAMPLE
Points:• If LIBOR > 5.5%, then …………… receives
the interest differential.
• If LIBOR < 5.5%, then ……………..receives the interest differential.
EXAMPLE1 2 3 4 5 6
Effective Dates LIBOR Floating-Rate Fixed-Rate Net Interest Received Net Interest ReceivedPayer's Payment* Payer's Payment** by Fixed-Rate Payer by Floating-Rate Payer
Column 3 - Column 4 Column 4 - Column 33/1/Y1 0.0459/1/Y1 0.050 $225,000 $275,000 -$50,000 $50,0003/1/Y2 0.055 $250,000 $275,000 -$25,000 $25,0009/1/Y2 0.060 $275,000 $275,000 $0 $03/1/Y3 0.065 $300,000 $275,000 $25,000 -$25,0009/1/Y3 0.070 $325,000 $275,000 $50,000 -$50,0003/1/Y4 $350,000 $275,000 $75,000 -$75,000
* (LIBOR/2)($10,000,000)** (.055/2)($10,000,000)
EXAMPLE
Points:• If LIBOR > 5.5%, then fixed payer receives
the interest differential.
• If LIBOR < 5.5%, then floating payer receives the interest differential.