Professional Documents
Culture Documents
Tim Mundhenke
Content Outline
1. 2. 3. Introduction What is a derivative? Reasons to use derivatives
4.
5. 6. 7. 8. 9.
Concepts to understand
Futures Forwards Options Swaps Questions
Introduction (I)
In the financial marketplace some instruments are regarded as fundamentals,
while others are regarded as derivatives.
Financial Marketplace
Derivatives
Fundamentals
Introduction (II)
Financial Marketplace
Futures
Forwards
Swaps
Underlying instrument such as a commodity, a stock, a stock index, an exchange rate, a bond, another derivative etc..
Forwards
Options
Swaps
Hedging:
Interest rate volatility Stock price volatility Exchage rate volatility Commodity prices volatility
VOLATILITY Speculation:
High portion of leverage Huge returns
EXTREMELY RISKY
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.
today on. How can you protect yourself from loosing if corn price happens to drop
until March by using corn forward contracts?
A futures contract makes unfavourable price movements less unfavourable and a favourable price movements less favourable!
If you are going to receive/buy something in the future but want to lock in a secured price, you take a long position.
A Forward Contract underlies the same principles as a future contract, besides the aspect of non-standardization. Thus, a detail illustration is not necessary as I already elaborated in the mechanism of the futures contract.
Options (I)
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.
Options (II)
The four basic positions: Call Option Write
Purchase
Purchase
Options (III)
Write & Purchase Call Option:
Value
Long Call
x
Stock Price at Expiration
Short Call
Options (IV)
Write & Purchase Call Option:
Long Call
Premium Earned x
Zero-Sum-Game
Premium Paid
Short Call
Options (V)
Write & Purchase Call Option:
Long Put
Short Put
Options (VI)
Write & Purchase Call Option:
Long Put
Premium Earned
Stock Price at Expiration
Short Put
Premium Paid
Swaps (I)
Swaps
Counterparties Interest rate swaps A swap is an agreement between two parties to exchange a sequence of cash flows.
Currency swaps
Phenomenal growth of the swap market Future and Option markets only provide for short term investment horizon Traded in OTC markets with little regulations No secondary market Market limited to institutional investors
Swaps (II)
A Plain Vanilla Interest Rate Swap:
An interest rate swap is an agreement between two parties to exchange a sequence of fixed interest rate payments against floating interest rate payments.
Terms to understand:
Fixed side Receive-fixed side Tenor Notional amount
Swaps (III)
Example:
5 year tenor; notional amount $1 million; Party A is the fixed side paying 9%, Party B is the receive-fixed side, paying a LIBOR flat rate
Party A 0 Party B 0
Libor*$1m
1
$90,000 $90,000
2
$90,000 $90,000
3
$90,000 $90,000
4
$90,000 $90,000
5
$90,000 $90,000
1
Libor*$1m
QUESTIONS