Derivatives

Contract

Underlying asset ( commodity, financial asset)

Contigent clams

Hedge the future risk

Types of the derivatives

 Forwards
 Futures
 Swaps
 Options

How they are traded

Exchanges

 They are organized

Over the counter

 Non-standardized
 Less liquid
 Higher cost of trade
 Credit risk

Forward contract

 Two parties
 Future commodity
 Predetermine price or forward price
 Future date
 There is obligation of both parties
 Over-the counter
 It is famous for exchange rate and interest rate

Future contract

 Two parties
 Its price can change on daily basis
 There should be margin account and you have to maintain the margin
 It can be specialized case of forward contract
 Obligations
 Exchanges

Payoffs for forward

Payoffs for long position

Sp(spot price)-K(delievery price or forward price)

Example:
On June, 1, 1998 bought gold forward at the future pirce of 400 and at maturity the price of 390.

So buyer will incure loss of 400-390=10 dollors

It is buyer.

Payoffs for short position

k-Sp

@ price of 390

400-390=10

@price of 410

400-410=-10

Structure of future market

Convergent of futures and spot rates