CCPS - C1

Banking Faculty Commercial Bank Division
DERIVATIVES
• Chapter 1: Introduction to Derivatives
• Chapter 2: Forward Contracts
• Chapter 3: Futures Contracts
• Chapter 4: Swaps
• Chapter 5: Options
2
Chapter 1: Introduction to Derivatives

Global derivative markets (B$)

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OTC ETM 4
Outline
1. Overview on derivatives market
2. Types of derivatives
3. Types of traders
4. Ways Derivatives are used
5
Introduction to Derivatives Market
1.1 History of Derivatives
1.2 Definition of Derivatives
1
1.3 Derivatives Market
6
History of derivatives
• Hedgers => Mediterannean
• 1700 BC: Jacob and his two wives
• 17th centuties: Osaka and rice forward contracts;
• 1697: Dojima Rice Exchange
• 1848: CBOT and “to arrive contract”
• 1972: CME, hợp đồng tương lai tiền tệ
• 1973: CBOE and Black Sholes Model
• 1980: WB, IBM and Swap
• Exotic vs Plain vanilla 7
Definition
• A derivative is defined as a financial instrument whose value
depends on (or derives from) the values of other, more basic,
underlying variables.
Công cụ phái sinh là công cụ tài chính mà giá trị của nó phụ thuộc vào một tài sản cơ sở đã được phát hành trước đó.
Thông thường công cụ phái sinh là một hợp đồng giữa hai bên nhằm trao đổi một số lượng chuẩn tài sản thực hay tài sản tài chính
theo giá xác định trước vào một ngày ấn định trước trong tương lai.
Bộ môn Ngân hàng Thương mại 8

Underlying variables
• The variables underlying derivatives are, very often, the prices of
traded assets.
• Underlying variables: wheat, orange juices, credit, interest rate,

electricity, weather, insurance…
Tài sản cơ sở có thể là hàng hoá, ngoại tệ, chứng khoán hoặc chỉ số chứng khoán.
Nếu giá trị của tài sản cơ sở trong hợp đồng thay đổi thì giá trị của công cụ phái sinh cũng thay đổi.
9
Derivatives market
Derivatives Market
Exchange-traded Market Over-The-Counter Market

Chứng khoán phái sinh được giao dịch tại sàn Thị trường phi tập trung
(TT tập trung)
Futures Options Forwards Swaps Options
10
Over-The-Counter Market- OTC

• The OTC market is an important alternative to exchanges. It is a
telephone- and computer-linked network of dealers
• Financial institutions often act as market makers for the more

commonly traded instruments.
- Thị trường OTC là một sự thay thế quan trọng cho các sàn giao dịch. Nó là một mạng liên kết giữa điện thoại và máy tính
của các đại lý
- Các tổ chức tài chính thường đóng vai trò là nhà tạo lập thị trường cho các công cụ được giao dịch phổ biến hơn.
*Thị trường OTC là thị trường không có trung tâm giao dịch chứng khoán tập trung, đó là một mạng lưới các nhà môi giới và tự
doanh chứng khoán mua bán với nhau và với các nhà đầu tư, các hoạt động giao dịch của thị trường OTC được diễn ra tại các
quầy (sàn giao dịch) của các ngân hàng và các công ty chứng khoán.
11
700000
OTC derivative markets (B$)

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Jun.98 Dec.99 Jun.01 Dec.02 Jun.04 Dec.05
Foreign exchange contracts Interest rate contracts Equity-linked contracts Commodity contracts Credit default swaps 12
Source: www.isda.org
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Exchange-traded Market
• A derivatives exchange is a market where individuals trade standardized
Sàn giao dịch phái sinh là thị trường nơi các cá
contracts that have been defined by the exchange. nhân giao dịch các hợp đồng tiêu chuẩn hóa
đã được sàn giao dịch xác định.
• The exchange acts as an intermediary between the buyer and seller and
mitigate the risk of default by either party in the intervening period by
requiring both parties to put up an initial amount of cash (margin)

• Sàn giao dịch đóng vai trò trung gian giữa người mua và người bán và giảm thiểu rủi ro vỡ nợ của một trong hai bên
trong giai đoạn can thiệp bằng cách yêu cầu cả hai bên đưa ra một lượng tiền mặt ban đầu (ký quỹ)
14
• Derivatives exchanges have existed for a long time:
• The Chicago Board of Trade (CBOT) was established in 1848 to bring
farmers and merchants together.
• the Chicago Mercantile Exchange (CME), was established in 1919
• The Chicago Board Options Exchange (CBOE) started trading call
option contracts on 16 stocks in 1973.

16
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North America Europe Asia and Pacific Other Markets
OTC Market Exchange-traded Market
Decentralized market Thị trường phi tập trung Centralized market
Counterparty risk Rủi ro đối tác No counterparty risk (Margins)
No centralized trading facility Không có cơ sở giao dịch tập trung Clearing house
Terms & conditions are between the
counterparties only Clear visibility for prices, start dates &
Các điều khoản & điều kiện chỉ giữa các
counterparties
bên đối tác

Characteristics of derivatives market

Size of markets is huge
The market is more liquid and flexible than other market
Various types of trading assets
The value of derivatives depends on the value of underlying

assets
Various types of participants
19
Types of Derivatives
1. Forward Contracts HĐ kỳ hạn
2. Futures Contracts
3. Swaps HĐ hoán đổi
4. Options HĐ quyền chọn
20
Forward contracts
• Definition: A forward contract is an agreement to buy or sell an
asset at a certain future time for a certain price
HĐ kỳ hạn là một thỏa thuận mua or bán một TS tại một thời điểm nhất định trong tương lai với một mức giá nhất định đã thỏa
thuận từ hôm nay
• It can be contrasted with a spot contract, which is an agreement

HĐ giao ngay
to buy or sell an asset today.
21
Types of traders
• Buyer - Long position: agrees to buy the underlying asset on
Vị thế mua
a certain specified future date for a certain specified price.
• Seller - Short position: agrees to sell the asset on the same

Vị thế bán
date for the same price.
22
Forward contracts
23
Characteristics of Forward Contracts

• Forward contract is a bilateral agreement
thỏa thuận song phương
• It is traded in the OTC market, usually between two financial

institutions or between a financial institution and one of its clients
24
Characteristics of Forward Contracts

• Forward contract is held to maturity by both parties
• Payoff of the contract is determined at maturity of the contract

- Hợp đồng kỳ hạn được giữ đến ngày đáo hạn bởi cả hai bên
- Khoản thanh toán của hợp đồng được xác định khi hợp đồng đáo hạn
25
Forward contracts
• Example: On July 20, 2015 the treasurer of a corporation
enters into a long forward contract to buy £1 million in six
months at an exchange rate of 1.7895
• This obligates the corporation to pay $1,789,500 for £1 million
on January 20, 2016
• What are the possible outcomes?
26
Futures Contracts
• Definition: Futures Contract is an agreement to buy or sell an
HĐ tương lai là một thỏa thuận giữa 2 bên để mua
asset for a certain price at a certain time. or bán một TS tại một thời điểm nhất định trong
tương lai với một mức giá nhất định
• Buyer - Long position: agrees to buy the underlying asset on

đồng ý mua TS vào 1
a certain specified future date for a certain specified price. ngày nhất định với
mức giá đã xđ trc
• Seller - Short position: agrees to sell the asset on the same

date for the same price.
27
Characteristics of Futures Market

• A futures contract is traded on an exchange Hợp đồng tương lai được giao dịch trên một sàn
giao dịch
• Contract terms are standardized Các điều khoản hợp đồng được tiêu chuẩn hóa
• The value of the contract is daily adjusted according to market price

(marked to market) Giá trị của hợp đồng được điều chỉnh hàng ngày theo giá thị trường (giá thị trường)
• Futures contract is normally terminated before expiration date

Hợp đồng tương lai thường được chấm dứt trước ngày hết hạn
28
Characteristics of Futures Market

• Available on a wide range of assets
• Exchange traded
• Specifications need to be defined:
• What can be delivered,
• Where it can be delivered, &
• When it can be delivered
• Settled daily
29
Swaps
• The first swap contracts were negotiated in the early 1980s
• An agreement to exchange cash flows on several future dates.
30
Swaps
Cash Flow Cash Flow

A B
A
Intel Microsoft
B
Financial Institution A
B
31
Options
• Definition: An option gives the holder the right to buy/sell the
underlying asset by a certain date for a certain price.
32
Options vs futures and forward
• Forward/Futures contract gives the holder the obligation to buy/sell

the underlying asset for a certain price
• Options contract gives the holder the rights to buy/sell the underlying
asset for a certain price
The holder has the rights to choose to exercises the right or not
when the market price changes and has to pay premium for the right
33
Options
• Terminologies:
• Spot price: the current market price of an asset
• Exercise price/Strike price: the price at which an option can be

exercised.
• Premium: the price the buyer has to pay to buy the option.
34
Options
35
Options
an option to buy a certain asset by a certain date
Call options for a certain price (the strike price)
an option to sell a certain asset by a certain date

Put options for a certain price (the strike price)
36
Options
American An American option can be exercised at any
Option time during its life
European A European option can be exercised only at

Option maturity
37
Specification of Options Contract

Underlying asset and volume of trading
Expiration date or maturity date
Call options/Put Options
Exercise price or strike price
Premium
38
Types of traders
• Hedgers
• Speculators
• Arbitrageurs
39
Hedgers
• Hedgers: are those who own underlying assets as goods,
securities… and use derivatives to reduce/limit their risk exposure
to price fluctuation on their investments
• Hedgers are basically risk adverse investors
40
Hedger
• A US company will pay £10 million for imports from Britain in 3
months and decides to hedge using a long position in a forward
contract
• An investor owns 1,000 Microsoft shares currently worth $28
per share. A two-month put with a strike price of $27.50 costs
$1. The investor decides to hedge by buying 10 contracts
41
Speculator
• Whereas hedgers want to avoid
exposure to adverse movements in
the price of an asset, speculators
wish to take a position in the
market to make profit.
• Derivatives are used as a special

leverage
42
Speculator
• Example: An investor with 7800USD to invest feels that a
stock price will increase over the next 2 months. The current
stock price is 78 USD and the price of a 2-month call option
with a strike of 80USD is 3 USD. An option is to buy 1 stock
• What are the alternative strategies?
• Compare risk and return in these strategies if the price of
stock after 3 months would be:
• P= 85USD/stock
• P = 70 USD/stock
43
• An investor with $2,000 to invest feels that a stock price will

increase over the next 2 months. The current stock price is $20
and the price of a 2-month call option with a strike of 22.50 is $1
• What are the alternative strategies?
44
Arbitrageurs
• Arbitrage involves locking in a riskless profit by
simultaneously entering into transactions in two or more
markets
• Arbitrageurs are not investors or speculators because they bear no

risk
45
Arbitrageurs
• Example: A stock price is quoted as £100 in London and $200 in
New York. The current exchange rate is 2.0300
• What is the arbitrage opportunity?
46
Question ?
• Speculators vs Arbitrageurs
47
Speculators vs Arbitrageurs
Speculators Arbitrageurs
the purchase or sale of an asset in the Arbitrage is the simultaneous purchase and
expectation of a gain from changes in the sale of equivalent assets
price of that asset
Initial invesment No initial investment
Price risk (uncertain profit) No risk onprice fluctuation
48
Speculators vs Hedgers
Speculators Hedgers
Profit seeking from price movement Hedge from price movement

• Sell => downside speculation • Long hedge => upside hedging
• Buy => upside speculation • Short hedge => downside hedging
49
Market Makers
• In practice, it is unlikely that two companies will contact each other
or a financial institution at the same time and want to take opposite
positions in exactly the same derivatives contract
• For this reason, many large financial institutions act as market

makers for deriavtives contract. This means that they are prepared
to enter into a derivatives contract without having an offsetting
contract with another counterparty
50
Purposes of derivatives trading

1
• Hedging
2
• Speculating
3
• Trading
4
• Transforming asset - liability
51
Hedging
• Example: A Vietnamese oil company exports oil to US. The

payment is made after 3 months at the market price on
expiration date.
Suppose that the expected price for the deal is 105USD/barel.
Current exchange rate is 21.500
• What risks is company exposed to ?
• What should company do to hedge the risk ?
52
Speculating
• Example: An investor thinks that a cold winter will destroy the orange
season in Florida and orange juice price will rocket
• How can the investor use derivatives to earn profit ?
53
Trading
• Financial institutions provide derivatives for their customers or act
as intermediary in derivatives contract and receive fees/premiums
54
Transform an asset/liability
Asset Liability
Loan: 100 m Deposit: 100 m

1 y; Ls: 10%/year 2 y: LS: Libor + 2%
Asset Liability
Loan: 100 m Deposit: 100 m
1 y; Ls: 10%/year 2 y: LS: Libor + 2%
Receive floating rate: Libor + Pay fixed rate: 8%
3%
Libor + 13% Libor + 10% 55
Interest rates
• Interest rates, compounding frequency, continuous
compounding
• Libor, zero rates…
• Spot rate, forward rate
56
Compounding frequency
When we compound m times per year at rate R an amount A grows to
A(1+R/m)m in one year
Compounding frequency Value of $100 in one year at 10%
Annual (m=1) 110.00
Semiannual (m=2) 110.25
Quarterly (m=4) 110.38
Monthly (m=12) 110.47
Weekly (m=52) 110.51
Daily (m=365) 110.52
57
Compounding frequency
V = A x (1+ Rm )mxn
m
• A: an amount invested at to
• V: an amount at expiration
• Rm: rate
• n: years
• m: compounding frequency ( times of interest payment)
58
Continuous compounding
3,00,000
e
2,500,000
2,00,000
59
Continuous Compounding
V = A x eRc*n
• A: an amount invested at to
• V: an amount at expiration
• Rc: Continuously Compounded rate
• n: years
60
Conversion Formulas
Define
Rc : continuously compounded rate
Rm: same rate with compounding m times per year
 Rm 
Rc  m ln 1  
 m 
Rm  m e  Rc / m
1 
61
Zero Rates
A zero rate (or spot rate), for maturity T is the rate of interest
earned on an investment that provides a payoff only at time T
62
Example
Maturity Zero Rate
(years) (% cont comp)
0.5 5.0
1.0 5.8
1.5 6.4
2.0 6.8
63
Bond Pricing
• To calculate the cash price of a bond we discount each cash
flow at the appropriate zero rate
• Ex: Calculate the theoretical price of a two-year bond providing
a 6% coupon semiannually
Options, Futures, and Other Derivatives 7th Edition, Copyright

64
© John C. Hull 2008
Forward Rates
• The forward rate is the future zero rate implied by today’s term structure of
interest rates
65
Forward rates
2 years investment @ R[0,2]
1st
0 1 2
2nd
1 year investment @ R[0,1]
1 year investment from end of year 1
@ R[1,2]
66
Calculation of Forward Rates
n-year Forward Rate

zero rate for n th Year
Year ( n ) (% per annum) (% per annum)
1 3.0
2 4.0 5.0
3 4.6 5.8
4 5.0 6.2
5 5.3 6.5
67
Formula for Forward Rates

• Suppose that the zero rates for time periods T1 and T2 are R1
and R2 with both rates continuously compounded.
• The forward rate for the period between times T1 and T2 is
R2 T2  R1 T1
T2  T1
• This formula is only approximately true when rates are not
expressed with continuous compounding
68

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Banking Faculty Commercial Bank Division

• Chapter 1: Introduction to Derivatives

• Chapter 2: Forward Contracts

• Chapter 3: Futures Contracts

Chapter 1: Introduction to Derivatives

Global derivative markets (B$)

4. Ways Derivatives are used

Introduction to Derivatives Market

1.1 History of Derivatives

1.2 Definition of Derivatives

depends on (or derives from) the values of other, more basic,

Bộ môn Ngân hàng Thương mại 8

• Underlying variables: wheat, orange juices, credit, interest rate,

Exchange-traded Market Over-The-Counter Market

Futures Options Forwards Swaps Options

Over-The-Counter Market- OTC

• Financial institutions often act as market makers for the more

OTC derivative markets (B$)

mitigate the risk of default by either party in the intervening period by

requiring both parties to put up an initial amount of cash (margin)

Bộ môn Ngân hàng Thương mại 15

OTC Market Exchange-traded Market

Decentralized market Thị trường phi tập trung Centralized market

Counterparty risk Rủi ro đối tác No counterparty risk (Margins)

Bộ môn Ngân hàng Thương mại 18

Characteristics of derivatives market

The market is more liquid and flexible than other market

Various types of trading assets

The value of derivatives depends on the value of underlying

4. Options HĐ quyền chọn

• It can be contrasted with a spot contract, which is an agreement

to buy or sell an asset today.

• Seller - Short position: agrees to sell the asset on the same

Characteristics of Forward Contracts

• It is traded in the OTC market, usually between two financial

Characteristics of Forward Contracts

• Payoff of the contract is determined at maturity of the contract

• Buyer - Long position: agrees to buy the underlying asset on

• Seller - Short position: agrees to sell the asset on the same

Characteristics of Futures Market

• The value of the contract is daily adjusted according to market price

• Futures contract is normally terminated before expiration date

Characteristics of Futures Market

• An agreement to exchange cash flows on several future dates.

Cash Flow Cash Flow

Options vs futures and forward

• Forward/Futures contract gives the holder the obligation to buy/sell

• Spot price: the current market price of an asset

• Exercise price/Strike price: the price at which an option can be

an option to sell a certain asset by a certain date

European A European option can be exercised only at

Specification of Options Contract

Expiration date or maturity date

Call options/Put Options

Exercise price or strike price

• Hedgers are basically risk adverse investors

• Derivatives are used as a special

• An investor with $2,000 to invest feels that a stock price will

• Arbitrageurs are not investors or speculators because they bear no