2/10/2017 How would you explain to a layman what a derivative instrument is?

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Daniel McLaury, Ph.D. Student in Mathematics at University of Illinois at
Chicago What is a derivative in layman's terms?
Written Sep 9, 2013
How can Communism be explained to a ten year old?
I'd give the example of a put option:
What is the meaning of torque and power in a car in
"If you pay me $5 right now, I'll agree to buy up to ten pounds of potatoes from you a month layman terms?

from now at a price of $2/pound."
What is the cloud? Can it be explained in terms that a
non­technical person can understand?
It's called a "derivative" product because its value is derived from the value of the
underlying product -- in this case, potatoes.  If, in a month, potatoes are worth only $1/lb, How can I explain limits (maths) to a layman?
you can buy ten pounds of potatoes for $10, then sell them to me for $20 and make a profit
How can the Halting Problem be explained to a
of $5 (because you made $10 and paid me $5 to start, ignoring the month's worth of interest layman?
on the $5).  If, on the other hand, they're worth $3/lb, then your contract will be worthless
since you wouldn't want to sell $3/lb potatoes to me for only $2/lb. How do explain transfer pricing to a layman?

How do I explain this equation to a layman?
Of course we can make more complicated derivatives, too, but it's the same basic idea -- a
product whose value is derived from the value of something else. How can I explain genetics to a layman?
3.7k Views · View Upvotes
How do you explain 2G network to a layman?

Anirudh Joshi, not all data is good data
Written Sep 9, 2013
All derivatives are insurance.

If something goes wrong with an asset whether that's a car, a house or a life, if you pay us X
amount today, we will pay you Y amount when something goes wrong.

The trick is in picking the right X and the right Y.

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Amit Pawar
Written Sep 9, 2013
DERIVATIVES : In simple term the derivative means you predict and betting on future
weather this will happen or not on the bases of current situation and your own interest.
 
 
 
DERIVATIVES
Derivatives are securities whose value is derived from the underlying security.
Examples of security: Such as bonds, stocks, currencies, commodities, an index or
temperature. 
 
 
Types of Derivatives.
 
Ø  Forward
Ø  Future
Ø  Options
Ø  Warrants
 
Necessity of Derivatives
Ø  Counterparty
Ø  Common Asset
Ø  Market
Ø  Contractual Agreement
 
 
Markets
 
Ø  CBOE-Chicago Board Options Exchange,
Ø  CBOT-Chicago Board of Trade, USA  
Ø  LIFFE-London international financial futures Exchanges (LIFFE).
Ø  BOX - Boston Options Exchange
Ø  EDX London - London's Equity Derivatives Exchange,  UK
 
 
Forward Contracts

Ø  Definition:-A forward contract is an agreement between two parties to buy or sell an asset
at a pre-agreed future point in time.
 
Ø The owner of a forward contract has the obligation to buy the underlying asset at a fixed
date in the future for a fixed price.
Ø  They are traded on, over the counter .

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as well as the location where delivery must be made.   Ø  In modern (financial) markets. if the value of the house is $ 1.00. etc. this specifies which bonds can be delivered. (i. Ø  The last trading date.2/10/2017 How would you explain to a layman what a derivative instrument is? ­ Quora     Search for questions.$1.000 on 1.04.2005. This can be the notional amount of bonds. making it easier for them to plan.e. Ø  The delivery month.1. the value of the house is $1.         Types of Future Contracts There are many different kinds of futures contract.00.000.1.1.   Ø  Example:- Ø  Commodities markets farmers often sell futures contracts for the crops and livestock they produce to guarantee a certain price. Similarly. usually by specifying: Ø  The underlying. In the case of bonds. the minimum permissible price fluctuation. & deposited in bank.000. a fixed number of barrels of oil. (spot price) layman terms?             “A” will gain $6000 and “B” will loose $ . Ø  The type of settlement.       Specification on a Future Contract   Futures contracts ensure their liquidity by being highly standardized. Ø  Situation 2: On 1.2006. This can be anything from a barrel of sweet crude oil to a short term interest rate.10.2006. and exchange traded   Ø  Some futures contracts may call for physical delivery of the asset. and topics Sign In   Related Questions What is a derivative in layman's terms? Example of how the payoff of a forward contract works   How can Communism be explained to a ten year old? Ø  “A” enters a forward contract to buys a house from “B” $1. while most are settled in cash.1. Ø  The grade of the deliverable. For example. livestock producers often purchase futures to cover their feed costs. units of foreign currency. this specifies not only the quality of the underlying goods but also the manner and location of delivery.000. if the value of the house is $1.com/How­would­you­explain­to­a­layman­what­a­derivative­instrument­is 3/9 .2005. he would earn at least 4% p. How can I explain genetics to a layman? Ø  Hence it would be ideal for A & B to enter into a one year’s forward contract (expire date How do you explain 2G network to a layman? 1.2006) for at least $1.   Ø  They are standardized. reflecting the many different kinds of tradable assets of which they are derivatives.04. the NYMEX Light Sweet Crude Oil contract specifies the acceptable sulfur content and API specific gravity.6. either cash settlement or physical settlement. the notional amount of the deposit over which the short term interest rate is traded.000       FUTURE CONTRACTS   Ø  Definition: Future contract is an obligation to buy or sell a specific quantity and quality of a commodity or security  at a certain price on a specified future date.000.1.04. Ø  Other details such as the commodity tick. (spot price) What is the cloud? Can it be explained in terms that a             “A” will loose $ -4000 and “B” will gain $4000 non­technical person can understand?   How can I explain limits (maths) to a layman?     How can the Halting Problem be explained to a Example of How Forward Prices Should Be Agreed Upon Considering the Time value layman?   Ø  On 1.1.quora. Ø  The amount and units of the underlying asset per contract.   Ø  Foreign exchange market   Ø  Bond market https://www. In the case of physical commodities.000) How do I explain this equation to a layman? Ø  If A takes a loan and buys the above house on 1.1. so that they can plan on a fixed cost for feed. Ø  The currency in which the futures contract is quoted.2005 What is the meaning of torque and power in a car in Ø  Situation 1: On 1. Ø  Margin percentage are specified. people.2005 he will have to at least pay 4% interest to the bank.a. "producers" of interest rate swaps or equity derivative products will use financial futures or equity index futures to reduce or remove the risk on the swap. How do explain transfer pricing to a layman? Ø  If B sold on 1.

  Ø  Initial Margin: While entering into a trade the investor pays an upfront some percentage of the total contract value as an initial margin money.quora. they How can I explain genetics to a layman? would sell in Spot and buy in futures. people. How do explain transfer pricing to a layman?   How do I explain this equation to a layman? Ø  Arbitragers also trade in future.000. and the futures price goes up by 1/2 point during a session.   Ø  Variation Margin: The cash transfer that takes place after each trading day (and sometimes intraday) in most futures markets to mark long and short positions to the market. and creates a credit risk to the exchange.2/10/2017 How would you explain to a layman what a derivative instrument is? ­ Quora   Search for questions. but commonly known as margin. and topics Ø  Money market Sign In   Ø  Equity index market Related Questions   Ø  Soft Commodities market What is a derivative in layman's terms?     How can Communism be explained to a ten year old?   What is the meaning of torque and power in a car in layman terms? What is the cloud? Can it be explained in terms that a Who trades futures? non­technical person can understand? How can I explain limits (maths) to a layman? Ø  Hedgers:-Hedgers. This renders the owner liable to adverse changes in value. in the US formally called performance bond. the exchange demands that contract owners post a form of collateral. they would buy in Spot and sell in futures or if they feel that the instrument is under priced . To minimize this risk. How do you explain 2G network to a layman?   Ø  Hedgers typically include producers and consumers of a commodity       Margin on Future Contracts Ø  Although the value of a contract at time of trading should be zero. Most contracts are settled daily by the payment of variation margin from the party who has lost money that day to the party who has made money. who have an interest in the underlying commodity and are seeking to hedge out the risk of price changes How can the Halting Problem be explained to a   layman? Ø  Speculators:-Speculators. who seek to make a profit by predicting market moves and buying a commodity "on paper" for which they have no practical use.com/How­would­you­explain­to­a­layman­what­a­derivative­instrument­is 4/9 . the short will pay the long $500 per contract in variation margin. who always acts as counterparty.   Ø  Example: If each point in the price of a contract is worth $1. its price constantly fluctuates. if they feel that the instrument in over priced.   Ø  Margin requirements are waived or reduced in some cases for hedgers who have physical ownership of the covered commodity or traders who have offsetting contracts       Future v/s Forward Contract        Future         Forward             Exchange traded         Over the counter             Standard contract         Customized contract             Margins         May not require margins             Daily Settlement         End of the period settlement             Liquid https://www.

      Call Options   Ø  An option contract that gives its holder the right (but not the obligation) to buy a specified number of shares of the underlying stock at a given strike price. only on its expiration date.quora. Most exercise prices gravitate around the current price of the underlying asset. Ø  Bermuda Option: A type of option that can only be exercised on predetermined dates.   Ø Expiration: The rights conferred upon the owner of an option are only valid for a certain period (until expiration) . How do I explain this equation to a layman?   Ø Unit of Trading: One option contract gives right over a fixed quantity of the underlying How can I explain genetics to a layman? asset. but not the obligation. If this does not occur prior to expiration. people. layman?     How do explain transfer pricing to a layman? Features of an option contract.   Ø Premium: The amount paid by the option buyer to the option writer for the right.(relating to the cutoff time for exercise instructions and to the rules of the clearing corporation). usually every month.     CALL OPTION STRATERGY   CALL OPTION (BUY Long (Right) Advantage if Price goes up   Price goes up-Profits unlimited If Price falls /remain same  losses limited to premium paid     Short (Obliged) Disadvantage if price goes down                                     Price goes up-Losses are unlimited If Price falls /remain same  profits are limited to premium received     https://www. non­technical person can understand?   How can I explain limits (maths) to a layman? Ø  An option is a type of derivative where the buyer has the right. and topics Sign In             No counter party risk Related Questions         Counter party risk What is a derivative in layman's terms?       How can Communism be explained to a ten year old?   What is the meaning of torque and power in a car in   layman terms? Options Contracts   What is the cloud? Can it be explained in terms that a Options .Definition. it can be exercised . It is 100 How do you explain 2G network to a layman? shares in the USA. on or before the expiration date of the contract is known as call option.   Ø Writer: The option seller is also known as the option writer. one individual equity option gives right over 1000 shares (in the UK). to buy (call option) or sell (put option) a commodity or financial asset at a specified price (the How can the Halting Problem be explained to a strike price) during a specified period of time in future. eg. Premium is determined by a intrinsic value and time value       Option Exercise Style   Ø  American option: Can be exercised at any time for both stock & indices Ø  European option: Can only be exercised on the expiry date for the underline stock or indices Ø  Capped-style Option:              The term "capped-style option" means an option contract that is automatically exercised when the cap price is reached.after this expiry date they are not legitimate.com/How­would­you­explain­to­a­layman­what­a­derivative­instrument­is 5/9 .2/10/2017 How would you explain to a layman what a derivative instrument is? ­ Quora         Illiquid Search for questions.   Ø Strike / Exercise Price: The price of which the option holder has the right to buy (or sell) the underlying asset.

e. Ø  Equity options:-Exchange traded equity options are "physical delivery" options. an in-the-money call option would be any listed call option with a strike price below $65.losses are unlimited How do you explain 2G network to a layman? If Price rises /remain same  profits are limited to premium received     Equity options. It gives the owner the right to receive physical delivery (if it is a call). intrinsic value is the positive difference between the current price for the underlying and the strike price of an option.20. Ø  If the market moves in your favour. it is also referred to as in-the-money. for a put option the strike price has to be over the price of the underlying. then the option has an intrinsic value of USD 0. Options are usually sold for their intrinsic value plus their time value       In the Money Option   An in-the-money call option is described as a call whose strike (exercise) price is lower than the present price of the underlying.2/10/2017 How would you explain to a layman what a derivative instrument is? ­ Quora Put Options   Search for questions. the option is $5.” https://www.       Intrinsic Value   Ø In options terminology. In other words. For a call option the strike price has to be under the price of the underlying. if the strike price for a call option is USD 1 and the price of the underlying is USD 1.without the obligation .quora.00 (the price of the stock). the MSFT January 60 call option would be an example of an in-the-money call. an option which could be exercised immediately for a cash credit should the option buyer wish to exercise the option.   Ø  For example. If an option has intrinsic value.       Example for ITM option        In our Microsoft example.to buy or sell the underlying shares at a fixed price by an appointed time. An in-the-money put is a put whose strike (exercise) price is higher than the present price of the underlying. if you get it wrong. Ø  If you buy an equity option.00 “in-the-money. The reason is that at any time prior to the expiration date. i.$60.00 of intrinsic value). all you lose is the price you paid for the option (premium). of underlying shares when the option is exercised. it is referred to as out-of-the-money. you could exercise the option and profit from the difference in value: in this case $5.00 stock price . people.com/How­would­you­explain­to­a­layman­what­a­derivative­instrument­is 6/9 . and topics Sign In Ø  An option contract that gives its holder the right (but not the obligation) to sell a specified number of shares of the underlying stock at a given strike price. if it has no intrinsic value.00 ($65. So.20. to larger amounts of shares for less initial cash outlay than would be possible when trading the actual shares. on or before the Related Questions expiration date of the contract is known as put option   What is a derivative in layman's terms?   PUT OPTION STRATERGY How can Communism be explained to a ten year old?   What is the meaning of torque and power in a car in PUT OPTION (SELL) layman terms?   Long (Right) What is the cloud? Can it be explained in terms that a Advantage if price goes down non­technical person can understand?   How can I explain limits (maths) to a layman? Price goes down-profits unlimited If Price rises /remain same How can the Halting Problem be explained to a  losses limited to premium paid layman?     How do explain transfer pricing to a layman? Short (Obliged) How do I explain this equation to a layman? Disadvantage if price rises   How can I explain genetics to a layman? Price goes down . you get the right .       Equity Option Trading Example   Ø  Equity options allow you to take advantage of share price movements by allowing you to gain exposure.00 call option strike price = $5. or to make physical delivery (if it is a put). you gain.

you would not want to do that.00 when the stock is trading at $65. people. the January $65. Similarly.00 in the open market.00 when the stock is trading at $65. you would essentially be choosing to buy the stock for $70.” How can Communism be explained to a ten year old?   What is the meaning of torque and power in a car in   layman terms?   What is the cloud? Can it be explained in terms that a   non­technical person can understand? Out of-the-money option How can I explain limits (maths) to a layman?   Ø  An out-of-the-money call is described as a call whose exercise price (strike price) is higher How can the Halting Problem be explained to a than the present price of the underlying. This action would result in a $5. the option is $5.00 in the open market. Related Questions It is in-the-money because at any time prior to the expiration date. if you chose to exercise the MSFT January 60 put while the stock was trading at$65.00. In other words.          Future         Options             Obligation to the buyer & seller to honor the   contract. since the holder has the option not to   exercise. For example. The MSFT January 70 put option Sign In would be an example of an in-the-money put. but not the obligation to buy   (or sell)             Aside from commissions. then the January $65. an in-the-money put option would be any listed put option Search for questions.00.00 call would an example of an at-the-money call option. you wouldn’t do that. you would be choosing to sell the stock at $60.00 (the price of the stock). For instance. There is no intrinsic value in an out-of-the-money put because the option’s strike price is lower than the current stock price.$65.00 put option strike What is a derivative in layman's terms? price .             Are more risky for those investors new to the market         Are less risky.00 “in- the-money.2/10/2017 How would you explain to a layman what a derivative instrument is? ­ Quora Using our Microsoft example.00 of intrinsic value.00 loss. An option on the index is at the money when the current index equals the strike price. spot price=strike price). This action would result in a $5.00 put would be an example of an at-the-money put option.         Example for ATM option An at-the-money option is described as an option whose exercise or strike price is approximately equal to the present price of the underlying stock. layman? There is no intrinsic value in an out-of-the-money call because the option’s strike price is How do explain transfer pricing to a layman? higher than the current stock price. if you chose to exercise the MSFT January 70 call while the stock was trading at $65. if Microsoft (MSFT) was trading at $65.e.00. (i. Obviously.com/How­would­you­explain­to­a­layman­what­a­derivative­instrument­is 7/9 . How do I explain this equation to a layman?     How can I explain genetics to a layman? Example for OTM option How do you explain 2G network to a layman?   Ø  For example. you could exercise the option and profit from the difference in value: in this case $5. and topics with a strike price above $65.         Gives the buyer the right. https://www. Obviously.money option (ATM) option is an option that would lead to a zero cash flow if it were exercised immediately.00 loss.00 ($70.       At-the-money-option   Ø  An at-the. An out-of-the-money put has an exercise price that is lower than the present price of the underlying.quora.00 stock price = $5.       Difference between Futures & Options.         Premium upfront (cost) is the maximum that a purchaser of   an option can lose. an investor can enter into a   futures contract with no upfront cost.

and the s&p500 index is the underlying asset. That's why they are called derivatives. Ø  A warrant is the right (but not the obligation) to buy or sell an underlying financial What is the cloud? Can it be explained in terms that a instrument at a specific price (strike price or exercise price) until a specific time (expiration non­technical person can understand? date).3k Views · View Upvotes Anonymous Written Sep 10. 885 Views · View Upvotes Related Questions How can the Halting Problem be explained to a layman? How do explain transfer pricing to a layman? How do I explain this equation to a layman? How can I explain genetics to a layman? How do you explain 2G network to a layman? How would you explain economic theory to a layman? How would you explain VANET to a layman? How can we explain financial systems to a layman? In layman's terms. If u think d company ll do well in future u can buy `call` options. Written Oct 11. Written Oct 27. the call is a derivative. options. the warrant investor gains economic exposure to this underlying security layman terms? without actually owning it. If share value goes down u make money. " A derivative can be defined as a financial instrument whose value depends on ( or derives from) the values of other . in this case. This is how future n options work.2k Views · View Upvotes Vinay Kumar. people. How can I explain limits (maths) to a layman? 3. which is called the underlying asset.quora. I read few non fictions too. Advantages of Financial Derivatives :- • Risk Management • Trading Efficiency • Speculation 1. For exemple. futures. ie their price is "derived" from the price of an other product. This just a basic explanation. it should be noted that other inputs are needed to calculated the price of the derivative/ 1. more basic variables" . Attempt-Maker. 2013 Lets say x company`s share value is 10$.com/How­would­you­explain­to­a­layman­what­a­derivative­instrument­is 8/9 . swaps etc.2k Views · View Upvotes How can the Halting Problem be explained to a layman? Divya Vyas. 2013 A derivative is a financial product that price derives from an other financial product. If share value increases u make money else u lose Ur money. Now either 2 things can happen share value reduces or increases. 2013 How do explain transfer pricing to a layman? Derivatives remain a type of financial instrument few of us understand and fewer still fully How do I explain this equation to a layman? appreciate. and topics Sign In     Related Questions Warrants Contracts What is a derivative in layman's terms? Warrants   How can Communism be explained to a ten year old? Ø It is a part of the derivatives family as their value depends on the value of an underlying What is the meaning of torque and power in a car in security. If you want to know more bout it watch movies like inside job or wall street. what is the Greek debt crisis? https://www. As such.2/10/2017 How would you explain to a layman what a derivative instrument is? ­ Quora       Search for questions.John C Hull Financial Derivatives includes different financial contracts like forward. although many of us have invested indirectly in derivatives by investing in mutual fund whose underlying assets may include derivative products. How can I explain genetics to a layman? Derivatives offer organisations the opportunity to break financial risks into smaller How do you explain 2G network to a layman? components and then to buy and sell those components to best meet specific risk management objectives. If u think d company might not do well then u buy `put` options. the price of an call on s&p500 derives from the price of the s&p500 index.

 2016 Updated Jan 21 Oh. this land was not summer I How can I explain genetics to a layman? most of the our land. either by force. One day this Empire? And maybe because if we did we owners. “Hey Mr. people. Sitemap # A B C D E F G H I J K L M N O P Q R S T U V W X Y Z About ­ Careers ­ Privacy ­ Terms ­ Contact https://www. notices Written Jul 28.com/How­would­you­explain­to­a­layman­what­a­derivative­instrument­is 9/9 . I'm just making layman? experiences. by treaty violation. It was then right up to me and out of the blue started these guys: And more of these guys: taken.2/10/2017 How would you explain to a layman what a derivative instrument is? ­ Quora What is the best analogy to explain current and voltage to a layman? Search for questions. I have a life.quora. How do I explain this equation to a layman? The Western Hemisphere: At So over the maybe because one time. Even our law was in charge everyone else and make a massive would recognize them as the rightful of a group of six year olds. asking me questions about girls. I have life everything up and hoping no one Alan Shepherd experiences. I have Ayden Jozwik. it belonged to the worked as American How do you explain 2G network to a layman? many indigenous peoples counselor at a population doesnt who found it first and day camp. and topics Sign In How would you explain fields (in physics) to a layman? How will you explain shorting to a layman? Related Questions How do you explain quantum field theory to a layman? What is a derivative in layman's terms? How does one explain gravitational waves for layman like me? How can Communism be explained to a ten year old? How would you explain the Gaussian distribution in layman's terms? What is the meaning of torque and power in a car in layman terms? Top Stories What is the cloud? Can it be explained in terms that a non­technical person can understand? What's the biggest thing ever What is the cutest mistake What's to stop the United States stolen? you’ve ever seen someone make? from deciding to conquer the How can I explain limits (maths) to a layman? world? How can the Halting Problem be explained to a Dave Consiglio. I dunno. by virtue of them having made boy in my group named Dylan walked Read More Read More would have to answer to these guys: And Read More the first legitimate claim. 2016 How do explain transfer pricing to a layman? Written Jun 3. and want to invade claimed it as their own.