Cisi Cmsa Derivatives Chapter 6 19 April 2021

International Introduction to Securities
& Investment
Dr. Daudi RVB Lwiza
Tumaini University Dar es Salaam College
(TUDARCo)
School of Business Studies (SoBS)
Mobile: +255 784 539 481/+255 653 539 483
Tuesday, May 31, 2022 DR.DAUDI LWIZA-SoBS-TURDARCo- 1
drlwiza.dl@gmail.com OR drlwiza@yahoo.com
DERIVATIVES
Topics covered (6 Questions out of 50)
1. Overview of Derivatives (What are derivatives and their uses
and players in derivative markets).
2. Futures
3. Options
4. Swaps
5. Derivatives Exchanges - Derivatives and Commodity Markets

DERIVATIVES
• WHAT ARE DERIVATIVES?
 DERIVATIVES are synthetic financial products or instruments
which are traded as financial contracts that safeguard the value or
price of the underlying currencies, securities or commodities that
are to be transacted or delivered during a contracted period or at
a specified future date.
 Derivatives as their name imply derive their value from the
underlying securities, curencies, or commodities that are traded in
the financial or commodities markets.
DR.DAUDI LWIZA-SoBS-TURDARCo-
Tuesday, May 31, 2022 3
drlwiza.dl@gmail.com OR
drlwiza@yahoo.com
DERIVATIVES
• WHAT ARE DERIVATIVES?...(cont.)
 Derivative products protect market participants against risk
associated with adverse movements in interest rates,
exchange rates and changes in the future prices and values
of securities, currencies and commodities that are to be delivered
at forward or future dates.
 For a small price, fee or premium, one can protect the underlying
assets of substantial value.

DERIVATIVES
• WHAT ARE DERIVATIVES?...(cont.)
For a premium, contract writers or hedgers are prepared
to bear risks on the behalf of other market participants.
The key types of derivatives products are: (i) forward
contracts/forwards; (ii) options; (iii) futures, (iv) swaps
(v) forward rates agreements (FRAs) and (vi) credit
derivatives.

DERIVATIVES
• AN OVERVIEW OF MAIN DERIVATIVE PRODUCTS
(1) OPTIONS – An option is a contract giving one party the right, but
not the obligation, to buy (call option) or sell (put option), a financial
instrument, stock, currencies, commodities or some other underlying
asset, at a given price, at or before a specified date.
(2) FUTURES – Are standardised agreements between counterparties
to undertake a transaction at agreed price, interest or exchange rate
on a specified date (it is an obligation). Futures are exchange-
traded.
(3) FORWARDS – Are private agreements between 2 parties to
undertake an exchange at an agreed date at a price agreed now.
Forwards are private agreements and are OTC-traded.

DERIVATIVES
• AN OVERVIEW OF MAIN DERIVATIVE PRODUCTS (cont.)
(4) SWAPS – Involve exchange of debt repayment obligations:
(i) Interest-rate swaps –involve the exchange of interest
obligations, e.g., fixed Vs floating; short-term Vs long-term
obligations; floating to floating obligations (basis swaps).
(ii) Currency swaps – involve the exchange of currencies and
interest obligations denominated in different currencies.
 Can be: sell/purchase swaps or purchase/sell swaps.
(iii) Credit Default swaps –Refer to page 109 and slide 52.

DERIVATIVES
• AN OVERVIEW OF MAIN DERIVATIVE PRODUCTS (cont.)
(5) FORWARD RATE AGREEMENTS (FRAs) – are arrangements where one party
(e.g., a bank) compensate the other party (borrower or depositor against the rise or
fall of interest rate over the agreed rates).
 Can be: caps, floors or collars.
(6) CREDIT DERIVATIVES – are used as means of protecting against credit risk.
e.g., credit default swaps, total return swaps, credit-linked notes, etc).
 Are essentially securities with a pay-off linked to a credit event e.g., borrower
default, credit rating downgrading or a structural change in a security
containing risk.
 In credit derivatives, there is a party (or bank) attempting to transfer credit risk,
known as protection buyer, and another party/bank (counterparty) attempting to
acquire credit risk, known as protection seller.
 Credit derivatives are usually transacted on unfunded basis (in some cases, may be
funded) –where the protection seller is not mandated to put in any funds upfront.
 It is only the protection buyer who is required to pay periodic premiums.
Uses of Derivatives
• Learning Objective :
Know the uses and application of derivatives,
Understand the following terms: ((i) OTC and (ii)
exchange-traded derivatives.
When trading takes place directly between
counterparties it is referred to as over-the-counter
(OTC) trading, and
 When it takes place on an exchange, such as the
Chicago Mercantile Exchange (CME), the derivatives
are referred to as being exchange-traded.
Uses of Derivatives
1. Hedging – This is a technique employed by portfolio managers to reduce
portfolio risk, such as the impact of adverse price, interest rates, exchange
rate movements on a portfolio’s value (Managing Market risks)
 This could be achieved by buying or selling futures contracts, buying put
options or selling call options.
2. Anticipating future cash flows – Closely linked to the idea of hedging, if a
portfolio manager expects to receive a large inflow of cash to be invested in a
particular asset, then futures can be used to fix the price at which it will be bought
and offset the risk that prices will have risen by the time the cash flow is
received.
 Or Anticipation of future changes in interest rates e.g. (i) fall of interest rates
by depositors and (ii) rise in interest rate by borrowers – interest rate futures
can be used to protect against changes in interest rates.

Uses of Derivatives
3. Asset allocation changes – Changes to the asset allocation of a fund,
whether to take advantage of anticipated short-term directional market
movements or to implement a change in strategy, can be made more swiftly
and less expensively using derivatives such as futures than by actually
buying and selling securities within the underlying portfolio.
4. Arbitrage – The process of deriving a risk-free profit from simultaneously
buying and selling the same asset in two different markets, when a
price difference between the two exists.
 If the price of a derivative and its underlying asset are mismatched, then the
portfolio manager may be able to profit from this pricing anomaly.
5. Speculation – involves assuming additional risk (betting) in an effort to
make, or increase, profits in the portfolio.
USES OFDERIVATIVES
• Uses OF DERIVATIVE PRODUCTS(DPs)…(cont.)
 SAME AS USE NO 1:Used to hedge/share against various financial risks –
associated with adverse movements in interest rates, exchange rates and
prices- provide a more efficient allocation of economic risks.
 From above, derivatives enable firms to plan with certainty. Buyers of
DPs are assured to get the contracted value of the underlying securities or
commodities or to make transactions at contracted interest and exchange
rates and prices.
 SAME AS USE NO 3: Implementation of asset allocation
decisions/strategies - enable low cost diversification and leverage + provide a
wide choice of financial asset classes and hence increased potential for
diversification.
 Price discovery and increased liquidity –they provide information about prices
movements of underlying assets.
 DPs enable f/institutions to make non-interest income in form of fees,
premiums or commissions (off-balance sheet income).

DERIVATIVES
MAIN PLAYERS IN DERIVATIVE MARKETS
(1) Banks
(2) Financial institutions
(3) Securities Firms/Investment Banks.
(4) Companies
(5) Investors
 Can be: buyers, sellers, intermediaries, hedgers,
arbitragers and speculators.
Definition of Derivative markets
• The derivatives markets are the financial markets for
derivatives.
• There are two types of derivative markets; exchange

traded derivatives and over-the-counter derivatives.
The legal, nature, products and how they operate is
what makes the difference between the two.

OTC derivatives market
• These are markets for directly traded and
privately negotiated derivative instruments
between two parties, without going through an
exchange or other intermediary.

Derivatives Exchange Markets
These are specialized markets for derivatives or
financial instruments.
A derivatives exchange acts as an intermediary

between seller and buyer, and takes initial margin
from both sides of the trade to act as a guarantee.

MAIN DERIVATIVES PRODUCTS
(1) FORWARD CONTRACTS (FORWARDS)
 Forwards are basically OTC agreements between 2 parties who agrees
to undertake an exchange at an agreed future date, at a predetermined
price that is fixed at the time of entering the contract.
 It enables to avoid adverse movements in prices and rates (interest and
exchange).
 The parties to the contract are assured to exchange the underlying
securities, commodities or currencies at specified price.
 The forward contract is tailor-made to meet the specific needs of the
contracting parties such as the amount to be exchanged and delivery
dates.
 Forward contracts as private agreements have the possibility of
default, especially if spot prices substantially move from agreed
forward prices.
 N.B: What are the main differences(10) between forwards and futures?
DIFFERENCES BETWEEN FUTURES AND FORWARDS
CONTRACTS

FUTURES
(2) FUTURES CONTRACTS/FUTURES
 Futures contracts are similar to forward contracts. The main
difference between the futures and forwards is that the futures
are traded in an exchange following standardised legal
agreements or terms for a specific quality of the underlying,
in specific amount and delivery dates.
 The 2nd difference is that the buyers and sellers of future

contracts transact through the intermediation of the
clearing house/exchange, which ensure the counterparties
are fulfilling their obligations, i.e. there is no default on the
counterparties.
FINANCIAL AND COMMODITY FUTURES
These are contracts to buy or sell real or financial assets
on a pre-arranged date in the future for a specified price.
Futures relate to a variety of financial instruments including
bonds, certificates of deposits, currencies and indexes.
 Apart from financial futures, there are commodity futures
for different commodity markets for agricultural products,
base and precious metals, energy markets (oil, natural gas
and coal), etc.

CHARACTERISTICS OF FUTURES
• Traded in highly organized markets like Eurex and LIFFE

so they carry standardized terms, amounts/quantity,
quality and maturities.
• They are highly liquid because they are tradable in the
secondary market.
• Usually offset /CLOSED OUT e.g. A purchase offset by a
sale or vice versa before delivery.

FUTURES….
• The clearing house requires both parties to deposit cash
against the transactions and this is known as initial margin.
• If a contract involves a party making a loss that is greater than

initial margin, further deposit are required on a daily basis from
the loosing party, these are called variation margin.
• If a counterparty defaults on futures contract the exchange

assumes the defaulting party’s position and the payment
obligations.

USES OF FUTURES: SPECULATION
Speculators take positions depending on their prediction

on price movement of underlying asset.
Long position (BUYING POSITION) when prices are
predicted to increase and
 Short position (SELLING POSITION) when prices are
predicted to decrease.
So as to earn profit from movements in futures prices.

USES OF FUTURES: HEDGING
Hedgers takes position in futures market to

cover themselves against exposures arising
from price movements of real or financial
assets or liability they are involved in.

FUTURES TERMINOLOGY
1. Long – the term used for the position taken by the

buyer of the future.
The person who is ‘long’ in the contract is committed
to buying the underlying asset at the pre-agreed price
on the specified future date.
2. Short – the position taken by the seller of the future.
The seller is committed to delivering the underlying
asset in exchange for the pre-agreed price on the
specified future date.
Futures Terminology (cont…)
3. Open – the initial trade. A market participant opens a trade when it
first enters into a future.
 It could be buying a future (opening a long position) or selling a future
(opening a short position).
4.Close – the physical assets underlying most futures that are opened
do not end up being delivered: they are closed-out instead.
 For example, an opening buyer will almost invariably avoid delivery
by making a closing sale before the delivery date.
 If the buyer does not close-out, he will pay the agreed sum and
receive physically the underlying asset.
FUTURES CONTRACTS - MAIN FEATURES
Use of standard contracts e.g., specified quantity,
grade/quality, coupon rate, maturity – increases the
marketability and liquidity of the contracts.
There is participation of a clearing house (futures
exchange) – safeguards the interest of buyers and
sellers and hence elimination of the default risk.
Margin requirements –Clearing house require
participants to keep margin money (initial margin and
variation margin) – (Read slide No. 22).

OPTIONS
Learning Objective:
1. Know the definition and functions of an
option.
2. Understand the following terms: calls and
puts.
3. Understand the following terms: holder;
writing; premium; covered; and naked

OPTIONS
(3) FINANCIAL OPTIONS

 According to Hudson et al (1998,p.415) “financial
option contracts are binding agreements between
two parties which give one party the right, but not
the obligation, to buy or sell an agreed quantity of a
particular currency, financial instrument, futures
contract, stock index or stocks at an agreed price
on or before a predetermined expiry date”.

OPTIONS
(3) FINANCIAL OPTIONS…(cont.)
Characteristics of financial options (from the definition of financial options):
(a) It is a binding contract between 2 parties.
(b) Parties to the contract: buyer = holder and seller = contract writer or
grantor; the seller has the obligation to perform once the buyer exercises
his/her right to buy
(c) It confers (i) the right to buy(=call option) or (ii) the right to sell (= put
option).
(d) At agreed price = exercise price = strike price.
(e) On or before a predetermined date or specified period:
- An American option is exercised on or before a
predetermined expiry date.
- An European option is exercised at any time, but delivery is
made only at the expiry date.

OPTIONS (cont…)
(3) FINANCIAL OPTIONS…(cont.)
(f) The call option has value or is: (i) “in-the-money” when the market price
is above the exercise price; MP>EP that is V =Max (MP- EP, 0), then
intrinsic value(IV)>0.
(ii) “out-of-money”, when the market price is below the exercise price;
MP<EP = it has zero IV (it can not have negative value).
(iii) “at-the-money”, when the MP = EP, then IV =0.
(e) The put option has value –is (i) “in-the-money, when MP<EP; V= Max
(EP - MP,0);(ii) “out-of-money”, when EP<MP and “at-the money, when
EP = MP.
-If the seller exercises the put option, it means that he/she sells the
underlying asset at the exercise price which is more than the market price
and thus has some gain.

OPTIONS (cont…)
3) FINANCIAL OPTIONS…(cont.)
(f) The price of a put or call option is called a premium = is the money paid by the
buyer to the writer at the beginning of the options contract - it is not
refundable.
 (N.B: You can skip material below up to slide 37 as are beyond the
requirement of your workbook, but are good for your in depth knowledge).
 The determinants of a premium are (see details in Harrington et. al (1990):
(i) Current price of the underlying instrument.
(ii) Exercise price/Strike price.
(iii) Time remaining to the expiration of the option.
(iv) Anticipated volatility of the underlying instrument.
(v) Level of the riskless short-term interest rate.
(vi) Anticipated cash dividend payments of the stock (for dividend paying stock/shares).

DETERMINANTS OF OPTION
PRICES/PREMIUM/VALUE
(1) EXERCISE PRICE (EP)
• All other factors being equal, the lower the EP, the higher the price for a call
option.
• For put options, the higher the EP, the higher the price
(2) TIME REMAINING TO THE EXPIRATION OF THE OPTION
• All other factors being equal, the longer the time to expiration of the option,
the greater the option price. As the time to exipiration decreases, less time
remain for stock price to change to compensate the option buyer for any
time value paid

(3) ANTICIPATED VOLATILITY OF THE UNDERLYING INSTRUMENTS:
• All other factors being equal, the greater the anticipated
volatility of the underlying price, the more an investor would be
willing to pay for the option and the more the option writer
would demand for it.
• The greater the volatility, the greater the probability that the
underlying price would move in favour of the option buyer
before expiration.

(4) CURRENT PRICE OF THE UNDERLYING (e.g., common
stock):
• The option price will change as the price of the underlying
change.
• For a call option, as the price of the underlying increases,
all other factors remaining constant, the option price
would increase.
• The opposite holds for a put option, as the underlying
price increases, the put price decreases.
(5) LEVEL OF RISK LESS SHORT-TERM INTEREST RATES.
• Note that a higher riskless short-term interest rates means a lower
effective exercise price.
• The price of a call option rises as the riskless short-term interest
rate rises
• For a put option, the opposite holds: the higher the riskless short-
term interest rate, the lower the price/premium.

(6) ANTICIPATED CASH DIVIDENDS PAYMENT OF THE
UNDERLYING STOCK:
• The greater the proportion of the stock’s expected return that will
come from anticipated cash dividends prior to the expiration date,
the lower the price/value of the call options.
• The opposite is true for a put option: the higher the anticipated
cash dividends prior to the expiration date, the higher the put
potion price/premium/value.

NAKED AND COVERED OPTIONS
• Naked option = Uncovered option for which the buyer

or seller does not own the underlying asset. It is either
a long position by the writer of a call option (right to buy)
or a short position by the writer of a put option (right to
sell).
• Naked options carry a chance of huge profit as well as of
great risk, depending on the market's direction.
• Naked options are the opposite of covered options.

NAKED AND COVERED OPTIONS
 COVERED OPTIONS = call or put option backed by ownership of the
underlying asset. Opposite of naked option. Also called covered put or
covered call.
 For example, a covered call refers to transaction in the financial market in which
the investor selling call options owns the equivalent amount of the underlying
security.
• To execute this an investor holding a long position in an asset then writes (sells)
call options on that same asset to generate an income stream.
• The investor's long position in the asset is the "cover" because it means the
seller can deliver the shares if the buyer of the call option chooses to exercise.
• If the investor simultaneously buys stock and writes call options against that
stock position, it is known as a "buy-write" transaction.
SWAPS
 Learning Objective:
1. Know the definition and function of an interest rate swap.
2. Know the definition and function of a credit default swap
(one type of credit derivatives – see slide 51).
A SWAP =“A swap is an agreement to exchange one set of
cash flows for another. Swaps are a form of OTC derivative
and are negotiated between the parties to meet their different
needs, so each tends to be unique” (CISI WOOKBOOK, pg.
108) or
A Swap is the exchange of one type of asset, cash flow, investment,
liability or payment for another.
What are the Benefits of Swap?
 Swaps have the following benefits:

1. Off-balance sheet transactions
2. Low transaction costs
3. Exchange of only cash flow payments
4. Provide opportunities for arbitrage
5. Provide for profitable access of markets
6. Hedging of interest rate and exchange rate risks.

Key Types of Swaps
1. Interest Rate Swaps
2. Currency Swaps
3. Basis Swaps

MAIN DERIVATIVES PRODUCTS (cont.)
(5) SWAPS
 A Swap is a financial contract to exchange payment obligations
A. INTEREST RATE SWAPS(IRS)
 IRS enable the counterparties to the deal to exchange their interest
obligations to match their assets and liabilities, that is, to match their
sources of funding and their corresponding investments.
 DEFINITION: An IRS is an agreement or contract that is entered

between 2 counterparties to exchange their interest obligations on a
notional amount over a specified period of time.
INTEREST RATE SWAPS
SWAPS (cont.)
 The participant to the agreement may exchange:
(i) The fixed rate interest obligations with floating rate
obligations. The fixed interest rate obligations are determined
over the duration of the notional debt at the time the contract is
agreed. While the floating obligations are determined periodically,
usually every 3 or 6 months based on the benchmark rate such as
LIBOR.
(ii) Floating to floating obligations, based on different benchmark
references/bases/rates e.g. LIBOR and PRIME RATE.
(iii) Short-term interest obligations with long-term interest
obligations.
Types of Swaps (Cont...)
Interest rate swaps are of three types;
– Coupon swaps: Offer the condition where two parties

exchange each other’s floating and fixed interest payments.
– Basis swaps: Offer the condition where one benchmark is
exchanged for another benchmark under floating rates, e.g.,
LIBOR and PRIME RATE.
– Cross currency swaps: Offer the condition where fixed rate
flows in one currency is exchanged for floating rate flows in
another currency.
SWAPS – CURRENCY SWAPS (cont…)
SWAPS (cont.)
B. CURRENCY SWAPS:
 This is an agreement that allows 2 counterparties to buy a certain
sum of foreign exchange from each other at the current market
price and at a later (forward) date to sell that foreign exchange to
each other (buy/sell or sell/buy transactions) at predetermined rate
set at the time of entering the agreement.
 During the duration of currency swap agreement, interest payment
are made for the amount of foreign exchange received.
 The interest payments may be on fixed basis on both currencies
or may be on floating basis for both currencies or alternatively
payments may be on floating basis for one currency and on
fixed basis on the corresponding currency.
Credit Derivatives
These are instruments that allow one party to

transfer an assets credit risk to another party without
transferring ownership of the underlying assets.
Credit derivatives have a wide range of structures

and can be used for both credit risk management
and for speculation.

Credit Derivatives Benefits
 Through its risk management benefits, banks and

other financial institutions provide credit intermediation
services.
 It provide these institutions with powerful tools to

manage such risk exposures. E.g. credit derivatives allow
banks to isolate and transfer their underlying loans in a
way that may not otherwise be possible due to legal or
relationship reasons.
Credit Derivatives Benefits (Cont...)
In addition, the instruments may help strengthen the

quality of a bank's loan portfolio, counteracting the loss
of higher quality credits to the securities markets.
It is important to recognize, however, that the benefits of

credit derivatives extend not only to the full range of
exposures arising from commercial banking, but also to
exposures from trading activities.

Categories of Credit Derivatives
• Credit Event Related Products: make payments
depending on the occurrence of a mutually
agreeable event.
• Credit Spread Products: are those whose payoffs
depend on how a particular credit spread changes.
• Mixtures: the most popular being the total return
swap (TRS), whose payoffs depend on the behavior
of spreads as well as on events such as defaults.

Types of Credit Derivatives
1. Credit Default Swaps

2. Total Rate of Return Swaps
3. Credit - Linked Notes
4. Credit Spread Options
5. Basket Default Swaps
6. Equity default swaps
7. Asset Swaps
Credit Default Swaps(CDSs)
(Also Read on these in your workbook pg.109)
• Most commonly-used credit derivative instrument.
• They facilitate the transfer of credit risk - but not market risk;
whereby the protection seller (investor) makes a payment to the
protection buyer in the event of default.
• The seller receives a periodic protection premium.
• Two parties enter into an agreement whereby one party pays the
other a fixed periodic coupon or premium for the specified life of the
agreement.
• The other party makes no payments unless a specified credit event
occurs.
Total Rate of Return Swaps
• A total rate of return swap (TRORS) is a credit
derivative instrument that enables a
counterparty to transfer the credit and market
risk associated with a reference asset to
counterparty, without transferring the asset
itself.
• A total return swap transfers the total economic
performance of a reference obligation from one
party (total return payer) to the other (total
return receiver).
Credit-Linked Notes
• A customized credit derivative structure normally
incorporating credit default swaps, but with some
distinct features and variations. This packages a
credit default swap into a tradable instrument - a
note or a bond.
• The credit linked notes may be issued either by
the protection buyer himself or by a special
purpose vehicle.

DERIVATIVE MARKETS
• Understand OTC Derivative Markets Vs Exchange-
traded Derivative Markets.
• The leading Derivative Markets in the world –110 -
111 and Commodity Markets - pg. 111 - 112.
• Potential advantages and disadvantages of
Investing in Derivatives –pg. 113.

Advantages and Disadvantages of Investing in
Derivatives
 Advantages:
• Enables producers and consumers of goods to agree the price of a
commodity today for future delivery, which can remove the uncertainty
of what price will be achieved for the producer and the risk of lack of
supply for the consumer.
• Enables investors and portfolio managers to hedge (reduce) the risk
associated with a portfolio of investments.
• Enables investment firms to hedge the risk associated with a portfolio or
an individual stock.
• Offers the ability to speculate on a wide range of assets and markets to
make large bets on price movements using the geared nature of derivatives.

Advantages and Disadvantages of Investing in
Derivatives
 Drawbacks and Risks:
• Some types of derivatives investing can involve the investor losing more
than their initial outlay and, in some cases, facing potentially
unlimited losses.
• Derivatives markets thrive on price volatility, meaning that professional
investment skills and experience are required.
• In the OTC markets, there is a risk that a counterparty may default on
their obligations, and so it requires great attention to detail in terms
of counterparty risk assessment, documentation and the taking of
collateral.
RISKS ASSOCIATED WITH DERIVATIVES
(1) Market Risk – risk of adverse movement in prices, interest rates,

exchange rates and index level volatility +other fluctuations in the
underlying instruments.
(2) Credit/default risk and/or settlement risk (risk that funds or instruments will
not be delivered when expected).
(3) Liquidity risk –Two forms: (i) entity may not be able to unwind or offset a
derivative transaction in a timely manner, or at near or near the
previous market price and (ii) funding liquidity risk = entity can not meet
its payment obligations on the settlement date or net margins calls due to
mismatches of inflows and outflows of funds.

RISKS ASSOCIATED WITH DERIVATIVES (cont.)
4. Legal risk = possibility that an entity may not be able to collect on the
winning position, or enforce a hedge, because a contract may not be
enforceable.
5. Regulatory Risk = possibility of changes in regulations governing may
adversely affect reported financial condition and earnings of
participants, given that regulations on derivative markets and
instruments are new and still evolving.
6. Operational risks = risk arising from human error, management
failure, fraud and shortcomings in systems and controls.

RISKS ASSOCIATED WITH DERIVATIVES (cont.)
7. Valuation or Model Risk - Valuation Models for

derivatives are complex mathematical models and in most
cases, beyond the know-how or thorough comprehension
of internal auditors and outside regulators.
8. Contagion Risk = systemic risk due to interconnection
and globalization of economies, across-border
transactions and financial markets (e.g. OTC derivative
dealers) – there may be domino effect in the case of a
failure of a larger dealer and turbulence can spread to
different markets nationally and world-wide.
***END***
CHAPTER/ELEMENT 6 -
DERIVATIVES
THANK YOU FOR YOUR ATTENTIVE LISTENING AND ACTIVE
PARTICIPATION.
I WISH YOU SUCCESS IN YOUR COMING PROFESSIONAL
EXAMINATIONS.
Dr. Daudi RVB Lwiza
Tumaini University Dar Es Salaam College (TUDARCo)
School of Business Studies (SoBS)
Mobile: +255 784 539 481/+255 653 539 483
Tuesday, May 31, 2022 61
DR.DAUDI LWIZA-SoBS-TURDARCo-

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• There are two types of derivative markets; exchange

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A derivatives exchange acts as an intermediary

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 The 2nd difference is that the buyers and sellers of future

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• Traded in highly organized markets like Eurex and LIFFE

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• If a contract involves a party making a loss that is greater than

• If a counterparty defaults on futures contract the exchange

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Speculators take positions depending on their prediction

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Hedgers takes position in futures market to

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1. Long – the term used for the position taken by the

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(3) FINANCIAL OPTIONS

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• Naked option = Uncovered option for which the buyer

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 Swaps have the following benefits:

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1. Interest Rate Swaps

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 DEFINITION: An IRS is an agreement or contract that is entered

– Coupon swaps: Offer the condition where two parties

These are instruments that allow one party to

Credit derivatives have a wide range of structures

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 Through its risk management benefits, banks and

 It provide these institutions with powerful tools to

In addition, the instruments may help strengthen the

It is important to recognize, however, that the benefits of

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1. Credit Default Swaps

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(1) Market Risk – risk of adverse movement in prices, interest rates,

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7. Valuation or Model Risk - Valuation Models for

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