FINANCIAL DERIVATIVES

You need to know: general characteristics, needs and diversity of financial derivatives; essence and peculiarities of futures contracts, forward contracts, option contracts and swap contracts. Bibliography

1. Ciobanu, Gh. Bursele de Valori i tranzaciile la burs. Bucureti: Editura Economica, 1997. - P. 29-60, 193-228. 2. Gradu, M. Tranzacii bursiere. Pieele futures i de opiuni. Bucureti: Editura Economica, 1995. P. 13-58, 100157. 3. 4. Popa, I. Bursa. Bucureti: Editura Adevrul, vol.I, 1993. - P. 62-213. Colburn, J.T. Trading in Options on Futures. - New York: New York Institute of Finance, 1990. PP.4-101. Kapner, K.R., Marshall J.F. The Swaps Handbook. Swaps and Related Risk Management Instruments. - New York: Kolb, Robert W. Financial Derivatives. - New York: New York Institute of Finance, 1993. PP.4-68.

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New York Institute of Finance, 1990. PP.11-158.

The futures contract is a standardized commitment between two partners, a buyer and a seller, to sell and, respectively, to buy a specific asset (foreign currencies, securities, other financial bonds, goods etc.) at a specific price established at the moment of concluding the transaction and the execution of the contract at a future date called maturity. The starting point in the appearance of the futures contracts are forward contracts. FORWARD CONTRACT Its a private commitment, concluded between two partners that know each other. FUTURES CONTRACT Its a standardised movable value by the market or the stock exchange which offer the respective contract. The buyer and the seller do not know each other. They know only the market where the transaction is being performed.

The underlying assets, or the object of the contract can be any merchandise or any other financial instrument for which the two partners show interest.

The underlying asset is not anymore decided by the parteners that sign the contract. The underlying asset is decided by the stock exchange which offers the contract,this way the characteristics and the quality of the underlying asset are sure defined,in the main time,the levels of inferior quality accepted for underlying assets alike are established,as well as the price differences which are going to be calculated in the case when the standart underlying asset is not being delivered.

The quantity that is going to be sold/bought, the price agreed and the maturity, are the elements of the future contract established taking into concideration the wishes of the two participants of the transaction.

The quantity of the underlying asset which is going to be delivered is established and standardised by the market that offers the contract.the maturity is also anounced ahead for this kind of contract. The price,though, is established using the demand/supply mechanism for the future contract for a specific underlying asset and influenced also by the maturity anounced for it.

No guaranties,or other sums of money are required at the moment of concluding such a contract.

In the moment of concluding the contract, i.e. the moment when the buyer or the seller takes its possition, they are asked to deposit a sum of money called margin or guaranty.

The basic elements of a future contract are:

the maturity of the contract. the trading unit or the underlying asset. the way of delivering the trading unit or the way of liquidating the position held by the buyer and/or the seller

of the contract, futures price the margin the contract parties, just like in every other contract, there two of them in the future contract, the seller of the

future contract and the buyer of the future contract;

o the buyer of the future contract is the investor who engages to buy the trading unit of the future contract at
maturity.

o the seller of the future contract is that investor who is engaged to sell the trading unit at maturity.
The execution of FUTURES contract is mandatory both for the buyer and seller, always one of them will record as a result a loss, and the other one a profit.

Options is a contract which gives the right and not the obligation to the buyer of the contract to buy or to sell, at a price and at the time settled before, against an amount of money, paid at the moment of signing the contract. Options are offered by specialized stock exchanges and are standardized. Options classification: 1.From the point of view of standardization and market of transaction options can be classified in options, negotiated:

a. On stock exchange markets. Options negotiated on stock exchange markets are standardized,
homogeneous-so they can not be perfect adapted to specific needs of each investor, but they have a high level of liquidity.

b. On interdealer market-are also called over the counter (OTC) options or unstandardized. Options that are
negotiated on this market, because of the adaption to the particular needs of the investor, have a lower level of liquidity.

2. According to the underlying asset of the option contracts, we distinguish: a. Options on securities with variable income (shares); b. Options on securities with fixed income (bonds), also called options on interest rate; c. Options on currency, also called currency options; d. Options on stock exchange indexes; e. Options on future contracts on shares; f. Options on future contracts on stock exchange indexes;

3. According to the moment of execution, there are:

a. Options of American type-the contract can be exercised at any time before the expiration date; b. Options of European type-the contract can be exercised only on the expiration date and not before.
Contrary to the name of the contract, in Europe most markets trade options of American type.

4.According to the buyers right, we identify:

a. Call option-is a standardized contract, which gives the buyer the right to buy the underlying asset from the
option writer at a specified price for a specified period of time. The call options seller is assuming the obligation to honor the buyers challenge through selling the underlying asset.

b. Put option-is a contract, which gives the buyer the right to sell the underlying asset to the options writer,
at a specified price and for a premium paid initially. At the same time, the put options seller is assuming the obligation to buy the underlying asset from the option buyer at a specified price, if the contract was executed at a specified period of time. The defining elements of an option contract are: maturity of the contract underlying asset execution price

 premium of the contract positions assumed by those who enter in an option contract

SWAP is the exchange of a financial instrument transferable with another. Practically, a SWAP represents an engagement between two or more parties to exchange certain securities(cash flows) in a future period.

SWAP contracts classification: Interest rate SWAP, represents exchanges in interest rates. For example a fixed interest and a variable one, is used intensively on bonds market and allows the conciliation of some divergent anticipations of issuers and investors. Debt SWAP is represented by the integral exchange of one debt with another debt, because of the differences between the depreciation forms or the lifecycle of each debt. Indexes SWAP, materialized in the change of indexes on which is calculated the level of the interest on borrowings. Devise SWAP, exchanges in financial flows restored in devises, stay at the origin of SWAP markets and is the biggest users of this technique. Crossed SWAP, which combines in the same time, both, interest and devise swaps.