Chapter 10 Derivatives markets

A derivative security is a financial instrument whose value depends on, or is derived from,
some underlying security.
The most common type of derivative contracts are a forward contract, a futures contract, an
options contract and swap
-they offer a inexpensive means of changing a firms risk profile.
- common risks factors are: interest rates, commodity prices, sharemarket indices and foreing
exchange rates.
- by taking position in a derivative security that offsets the firms risk profile, the firm can limit how
much its value is affected by changes in the risk factor.

FORWARD MARKETS
A forward contract involves two parties agreeing today on a price, called the forward price, at which
the purchaser will buy a specified amount of an asset from the seller at a fixed date sometime in the
future.
-different from cash markets using spot price( an observed price at which current transactions take
place)
- the buyer of a forward contract is said to have a long position ( an agreement to buy in the futures
market) and is obligated to pay the forward price for the asset.
- the seller is said to have a short position ( an agreement to sell in the futures market) and is
obligated to sell the asset to the buyer in exchange for the forward price.
- the future date on which the buyer pays the seller ( and the seller delivers the asset to the buyer) is
referred to as the settlement date.
- the forward price for an asset is that price that makes the forward contract have zero net present
value.
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