Derivative Level I

Derivatives
Training Material
Level I
Table of Contents
Overview of Derivatives contracts Risk and Hedging Vs Speculation

1 Introduction Types of derivatives
Spectrum of Derivative Contracts
Features of Derivatives
Example
Uses derivatives Market Players and Counter parties
Introduction to Forward Contracts

Features of Forward Contracts
2 Forwards Payoffs in Forward Contracts
High level Trade Life Cycle
Introduction to Futures Margin Account

Features of Futures Contracts High level Trade Life Cycle
3 Futures Payoffs in Futures Contracts
Forwards Vs Futures
Introduction to Options Options Value and Product

Types of Options structure
4 Options Definitions of Contract Terms High level Trade Life Cycle
Exercising Vs Trading
Introduction to Swaps Types of Swaps

Interest Rate Swap - Example Exiting a swap contract
5 Swaps Payoffs in Swap Contracts High level Trade Life Cycle
Netting
2
Confidential ©2009 Syntel, Inc.
Introduction to Derivatives
Derivatives – Overview
What is a Derivatives contract?
A financial contract of pre-determined duration, whose value is derived from the value of an underlying
asset. Since derivatives derive their value from the underlying asset, they are called as derivatives.
Underlying Asset
Bullion Securities Interest Exchange Currency Precious Commodities Index

Rate Rate metals
What do the derivatives do?
Derivatives are tools for transferring risk
Derivatives attempt to minimize the loss arising from adverse price movements of the
underlying asset
Derivatives attempt to maximize the profits arising out of favorable price fluctuation
4
Types of Derivatives
Classification of derivatives
Financial Derivatives
Commodity Derivatives
Based on Underlying Asset
Index Derivative
Credit Derivatives
Forward contracts
Future Contracts
Based on nature of the contract
Option Contracts
Swaps
Exchange Traded Derivatives

(e.g. DJIA Index future)
Based on markets in which they
Over The Counter Derivatives
are traded
(e.g. A forward contract / Repo
5
Spectrum of Derivative Contracts
Types of derivative contracts
Exchange Traded Over The Counter

Underlying Asset
Futures Options Swaps Forwards Options
Equity Stock Future Stock Options Equity Swaps Reverse Repo Stock Options
Index Future Index Options Warrants
Interest Rate Interest Rate Option on Interest Interest Rate Forward Rate Interest rate cap
Future Rate Swap Agreement and floor
Swaption
Bond Option
Currency Currency Future Option on Currency swap Currency Forward Currency Option
Currency Future
Commodity Commodity Options with Commodity swap Commodity Gold Option

Futures commodity as Forward
underlying agreement
6
How are these derivatives used?
 Derivatives are used to transfer risk. Hedging is the most

important method of derivatives and also their basic
economic purpose.
 Derivatives can be compared to an insurance policy. As

one pays premium in advance to an insurance company in
protection against a specific event, the derivative products
have a payoff contingent upon the occurrence of some event
for which he pays premium in advance.
 Speculate and make a profit if the value of the underlying

asset moves the way they expect.
7
What is Risk?
The concept of risk is simple. It is the potential for change in the price or value of some asset
or commodity. The meaning of risk is not restricted just to the potential for loss.
There is upside risk and there is downside risk as well.
Financial risks can be categorized as below:
Credit Risk Market Risk Liquidity Risk
Liquidity Risk Operational Risk Systematic Risk
Reputational Risk
8
Hedging Vs Speculation
Hedging is a method for reducing risk where a combination of assets are

selected to offset the movements of each other. Hedging means taking a
position in the futures market that is opposite to the one in the physical
Hedging market with the objective of mitigating or controlling the risks associated.
An example of a hedge would be if you owned a stock, then sold a futures
contract stating that you will sell your stock at a set price, therefore
avoiding market fluctuations.
Derivatives can also be used to acquire risk, rather than just to insure or
hedge against risk. Thus, Speculators look to buy an asset in the future at
Speculation a low price according to a derivative contract when the future market price
is high, or to sell an asset in the future at a high price according to a
derivative contract when the future market price is low.
Individuals and institutions may also look for arbitrage opportunities, as

when the current buying price of an asset falls below the price specified in
Arbitrage
a futures contract to sell the asset. (Wikipedia)
E.g. Forward FX contracts can be traded for Speculation and Arbitrage
9
Example
As discussed, Derivatives are used for risk mitigation. Lets have look at basic derivative instrument as a
example to understand the same.
For example, ITC corporation, exports goods to Germany and expects payment in Euro (EUR) in 3 months,
would enter FX forward contract to eliminate the risk of a depreciation of the FX at the time that the payment
arrives.
Hedged Item Hedging Instrument
Company must receive EUR Bank buys 1,000,000 EUR

forward at forward rate of 73.750
1,000,000 in 3 months
Spot rate INR/EUR: 73.000
Treasurer believes EUR will  FX risk: Company is
depreciate during next 3 months protected against large
adverse FX rate movements
 Exposure to FX risk: If FX rate is unfavorable in 3

months (i.e., > 73.750),
Company pays just 73.750
What will be exchange rate
INR/EUR in three months??
10
Market Players and Counter Parties
Players Counter Parties

Hedgers: The holders of the long Regulatory Bodies: Agency or a
position in derivative contracts (the body formed to standardize and the
buyers), are trying to secure as low future market. (e.g. CFTC)
a price as possible. The short
holders of the contract (the sellers)
will want to secure as high a price
Exchange: Facilitates trading for
as possible. The derivative contract,
regulated contracts trading
however, provides a definite price
certainty for both parties, which
reduces the risks associated with
price volatility. Brokers: who registered with
regulatory authorities, facilitate
future trading executions as they are
Speculators: On the other hand, members of futures stock exchange.
parties (buyer & Seller) rather to
benefit from the inherently risky
nature of the derivative market. Banks: Facilitates trading for OTC
These are the speculators, and they driven instruments and acts as
aim to profit from the very price agents and counter parties
change that hedgers are protecting
themselves against. Hedgers want
to minimize their risk no matter what Clearing house: Acts as counter
they're investing in, while party for futures settlements
speculators want to increase their
risk and therefore maximize the
profits.
11
Forwards
Forward Contract
Introduction
Price Premium / Discount: The difference between the
spot and the forward price is the forward premium
A forward contract is a non- or forward discount.
standardized contract between
two parties to buy or sell an
asset at a specified future time at
a price agreed upon today. This Parties There will be two counter parties in Forward
is in contrast to a spot contract,
contract i.e. Buyers and Sellers.
which is an agreement to buy or
sell an asset today. The party
agreeing to buy the underlying
asset in the future assumes a Long: Counter party who agreed to buy the
long position, and the party underlying asset is called long and said to be
agreeing to sell the asset in the Position assumed as long position.
future assumes a short position. Short: Counter party who agreed to sell the
The price agreed upon is called underlying asset is called short and said to be
the delivery price, which is equal assumed as short position.
to the forward price at the time
the contract is entered into
13
Features of Forward Contracts
Following are basic features of a forward contract
Forwards traded on OTC hence it is unregulated market
Contracts are of customized sizes and maturities. This helps create a perfect hedge if
needed.
Participants must negotiate rates and prices
Prices depend on credit risk and relationship
Custom made product may be difficult to exit
There will be one delivery date
Credit risk of counterparty may be huge
There is no margin system.
14
Payoffs in Forward Contract
Example: Mr. „X‟ (India) imports goods from Mr. Y (USA). Goods Value $100,000, Delivery 3 months
shipment. In order to avoid risk involved with exchange rate fluctuations Mr. X enters into forward contract
with an ABC bank to buy USD $100,000 at Rs 50 per a dollar after 3 months
Bank (Buyer) earns profit when spot price more Mr. X (seller) earns profit when spot price is less
than delivery price. than delivery price.
Long forward Payoff Short forward Payoff
Long
Spot Price
Spot Price
Short
The value of a forward position at maturity depends on the relationship between the
delivery price and the spot price.
15
Trade Life Cycle
Product Structure Trade Life Cycle
Buyer Seller
Forward contracts are non-
standardized and hence they
are associated with risk.
Forwards are entered in “over Contract Date Contract Agreement OTC

the counter” (OTC) market.
Deliverable forwards: Goods

are delivered Physically.
Valuation: Premium / Discount
Non-deliverable forwards:
only the gain or loss is Delivery Date
exchanged (e.g. FX forwards)
Settlement: Contract Amount or
Net of gain / loss (NDF)
16
Futures
Futures Contract
Definition Contract Terms
 Long: The party agreeing to buy the underlying asset in

A futures contract is a type of the future, the "buyer" of the contract, is said to be "long“.
derivative instrument, or financial
contract, in which two parties agree to  Short: The party agreeing to sell the asset in the future,
transact a set of financial instruments the "seller" of the contract, is said to be "short".
or physical commodities for future
delivery at a particular price.  Strike price: Price at which futures contract will be
settled on delivery date.
 Delivery Date: Date on which Futures contract is settled

at strike price.
 Underlying asset: Asset which is exchanged by one

party to another in futures contract on delivery date at
strike price.
 Spot Price: Price at which underlying asset is traded or

prevailing market price of underlying asset.
18
Features of Futures Contracts
Following are basic features of a futures contract
Futures are traded on a exchange and hence contracts regulated and highly controlled.
Standardized sizes and expiration periods. Hedge position may not provide an exact
dollar-for dollar offset to underlying exposure.
Pricing is extremely efficient. No negotiations.
Prices are the same for all.
Liquidity and flexibility. Hedge position may be entered and exited when needed.
Delivery is realized several days after maturity.
There is no credit risk.
Margin system may be expensive.
19
Profit & loss
Lets say a wheat farmer (Seller) and a bread maker (Buyer) may enter into a futures contract requiring the
delivery of 5,000 kgs of wheat to the buyer in June at a price of $4 per kg. By entering into this futures
contract, the farmer and the bread maker secure a price that both parties believe will be a fair price in
June.
The long makes money when the underlying assets The short makes money when the underlying asset‟s
price rises above the futures price or vice versa. price falls below the futures price or vice versa.
Long Short
Long
Future Price Future Price

Short
Lets say spot price wheat increases to $5 per kg the day after the above farmer and bread maker entered
into their futures contract of $4 per kg. The farmer, as the holder of the short position, has lost $1 per kg
because the selling price just increased from the future price at which he is obliged to sell his wheat. The
bread maker, as the long position, has profited by $1 per kg because the price he is obliged to pay is less
than what the rest of the market is This tutorial can be found at: obliged to pay in the future for wheat.
20
Forwards Vs Futures
Forward contracts are often confused with futures contracts. The confusion is primarily
because both serve essentially the same economic functions of allocating risk in the presence
of future price uncertainty. However futures are a significant improvement over the forward
contracts as they eliminate counterparty risk and offer more liquidity. Below Table lists the
distinction.
Futures Forwards
Traded on an organized exchange Over The Counter in nature
Standardized contract terms Customized contract terms
More liquid Less liquid
Requires margin payments No margin payment
Follows daily settlement Settlement happens at end of period
21
Margin Account
Margin Mark to Market
Margin amount is deposit amount for „good faith‟ Daily Settlement: As futures are traded on a
held with futures exchange by the counter exchange, both parties are required to put up an
parties of futures contract and they are two initial amount of cash, the margin. Since the
types. futures price will generally change daily, the
difference in the prior agreed-upon price and the
Initial Margin: the futures futures price is settled daily also. The exchange
exchange will state a minimum will draw money out of one party's margin
amount of money that you must account and put it into the other's so that each
deposit into counter party party has the appropriate daily loss or profit. If the
account. This original deposit of margin account goes below a certain value, then
money is called the initial a margin call is made and the account owner
margin. It will 5% to 10% of must replenish the margin account. This process
futures contract. is known as marking to market.
Maintenance margin:
Maintenance margin is the = =
lowest amount an account can
reach before needing to be
replenished. This will decide In given example, Farmer margin account is
when to make margin call debited with $5,000 and bread maker margin is
credited with $5,000.00 as spot price raised by $1
(5000 kg * $1 = $5,000)
22
Trade Cycle
Prime Broker Exchange
Places order Executes order
Client
Middle Office
Confirmation
Affirmation
Trade sent for
settlement
Trade Data
Reporting
Margin Calls
Net Settlement Daily

Client Services
Back Office
Settlement House
23
Options
Options
What is an Option contract?
An option is a contract that gives the buyer the right, but not the obligation, to buy or
sell an underlying asset at a specific price on or before a certain date. An option, just
like a stock or bond, is a security. It is also a binding contract with strictly defined
terms and properties. The price of an option derives from the difference between the
reference price and the value of the underlying asset (commonly a stock, a bond, a
currency or a futures contract) plus a premium based on the time remaining until the
expiration of the option.
For example, that you find a house that you'd like to purchase. Unfortunately, you won't have the cash to buy
it for another three months. You talk to the owner and negotiate a deal that gives you an option to buy the
house in three months for a price of $200,000. The owner agrees, but for this option, you pay a price of
$3,000.
Consider below two theoretical situations
Market value of House went to $1 M as there is While touring the house, you discover that some
news about coming industries at near area. defaults in the house and you now consider it
Because the owner sold you the option, he is worthless. On the upside, because you bought an
obligated to sell you the house for $200,000. In the option, you are under no obligation
end, you stand to make a to go through with the sale. Of course,
profit of $797,000 ($1 million you still lose the $3,000 price of the
- $200,000 - $3,000). Option.
25
Types of Options
Calls & Puts
Call Option Put Option
A call gives the holder the right to buy an asset at A put gives the holder the right to sell an asset at
a certain price within a specific period of time. a certain price within a specific period of time.
Calls are similar to having a long position on a Puts are very similar to having a short position on
stock. Buyers of calls hope that the stock will a stock. Buyers of puts hope that the price of the
increase substantially before the option expires. stock will fall before the option expires.
Option exercise
American style European style
American style options can be exercised at any European style options are different from
time between the date of purchase and the American options in that they can only be
expiration date. The example about Cory's Tequila exercised at the end of their lives.
Co. is an example of the use of an American
option. Most exchange-traded options are of this
type.
26
Definitions
Underlying Asset This is the specific security / asset on which an options contract is based.
Premium is the price paid by the buyer to the seller to acquire the right to buy or sell. It
Option Premium is the total cost of an option. It is the difference between the higher price paid for a
security and the security's face amount at issue. The premium of an option is basically
the sum of the option's intrinsic and time value.
Price of an option is the specified/ pre-determined price of the underlying asset at which
Strike Price the same can be bought or sold if the option buyer exercises his right to buy/ sell on or
before the expiration day.
Exercise An action by an option holder taking advantage of a favorable market situation .‟Trade
in‟ the option for stock.
Expiration date The date on which the option expires is known as Expiration Date.
Exercise Date Exercise date is the date on which the option is actually exercised.
Option Holder Party who buy the option contract is called as holder.
Option Seller Party who sells the options in other words write the options is called as Options seller.
27
Exercising Versus Trading-Out
Long Call Long Put
Long Call
Profit Short Put Loss
Strike Price Strike Price

Loss Price rises Profit
Short put Short Call
Premium Loss
Price Falls
Strike Price Strike Price
Premium
Loss
One makes money by trading out (closing the Long Put One makes money by trading out (closing the
position) the long call / short put when market Short Call position) the long put / short call when market
price for underlying asset rises. price for underlying asset falls.
28
Options Value and Product structure
The majority of the time holders choose to take their profits by trading out (closing out) their position.
This means that holders sell their options in the market, and writers buy their positions back to close.
Option Value Product structure

In-the-money: For a call option, in-the-money is
when the option's strike price is below the market Most of options are organized/standardized
price of the underlying stock. For a put option, in contracts in terms of quantity, quality, delivery time
the money is when the strike price is above the and place for settlement on any date in future.
market price of the underlying stock. In other These contracts are traded on exchanges.
words, this is when the stock option is worth
money and can be turned around and exercised There are some options traded in OTC.
for a profit.
Listed Options are cleared through option
Intrinsic Value: The intrinsic value of an option is clearing house and hence credit risk and
defined as the amount by which an option is in- counterparty risk are controlled.
the-money, or the immediate exercise value of the
option when the underlying position is marked-to- Options will give right to the buyer and hence
market. loss can be avoided by paying premium.
Call option
Option will give obligation to seller and hence
Intrinsic Value = Spot Price - Strike Price
they premium can be covered against loss.
Put option
Intrinsic Value = Strike Price - Spot Price
29
Trade Cycle
Prime Broker Exchange
Places order Executes order
Client
Middle Office
Confirmation
Allocation
Affirmation
Trade sent for
settlement
Trade Data
Reporting
Settlement
Client Services
Back Office
Settlement House
30
Swaps
Swaps - Introduction
What are Swaps?
An agreement between two parties to exchange (swapping) one set of cash flows for
another. In essence it is a portfolio of forward contracts. While a forward contract involves
one exchange at a specific future date, a swap contract entitles multiple exchanges over a
period of time. The most popular are Interest rate swaps and currency swaps.
Swaps are not exchange-traded instruments. Instead, swaps are customized contracts
that are traded in the over-the-counter (OTC) market between private parties. Firms and
financial institutions dominate the swaps market, with few (if any) individuals ever
participating.
Definitions
Notional: The cash flows are calculated over a notional principal amount, which is usually not exchanged
between counterparties. Consequently, swaps can be in cash or collateral.
Legs: the two counterparties agree to exchange one stream of cash flows against another stream. These
streams are called the legs of the swap.
Who would use a swap?
The motivations for using swap contracts fall into two basic categories: commercial needs and comparative
advantage. The normal business operations of some firms lead to certain types of interest rate or currency
exposures that swaps can alleviate. For example, consider a bank, which pays a floating rate of interest on
deposits and earns a fixed rate of interest on loans. This mismatch between assets and liabilities can cause
tremendous difficulties. The bank could use a fixed-pay swap (pay a fixed rate and receive a floating rate) to
convert its fixed-rate assets into floating-rate assets, which would match up well with its floating-rate liabilities.
32
Interest Rate Swap - Example
Lets let look at plain vanilla swap for basic understating:
LIBOR
Counter Party Counter Party
A Rs50,00,00,000.00 – Notional Principle B
Fixed Rate of 12%

„A‟ is the fixed rate receiver and variable rate payer.
„B‟ is the variable rate receiver and fixed rate payer.
The most common and simplest swap is a "plain vanilla" interest rate swap. In this swap, Party A agrees to pay
Party B a predetermined, fixed rate of interest on a notional principal on specific dates for a specified period of
time. Concurrently, Party B agrees to make payments based on a floating interest rate to Party A on that same
notional principal on the same specified dates for the same specified time period. In a plain vanilla swap, the
two cash flows are paid in the same currency. The specified payment dates are called settlement dates, and
the time between are called settlement periods. Because swaps are customized contracts, interest payments
may be made annually, quarterly, monthly, or at any other interval determined by the parties.
The only Rupee exchanged between the parties are the net interest payment, not the notional
principle amount.
In the given e.g. A pays LIBOR/2*50crs to B once every six months. Say LIBOR=5% then A pays
be 5%/2*50crs= 1.25crs
B pays A 12%/2*50crs=3crs
The value of the swap will fluctuate with market interest rates.
If interest rates decline fixed rate payer is at a loss, If interest rates rise variable rate payer is at
a loss. Conversely if rates rise fixed rate payer profits and floating rate payer looses.
33
Netting
When Floating Rate is higher than Fixed When USD loan Rate is higher than that
rate, net calculation is paid to ctpy B. of INR, net calculation is paid to ctpy B
Pay Offs USD

Pay Offs Floating loan Rate
Rate
INR Loan
B ctpy B ctpy
Fixed Rate
Pay Offs INR

Pay Offs Fixed loan Rate
Rate
A ctpy A ctpy
When Fixed Rate is higher than Floating When INR loan Rate is higher than that
rate, net calculation is paid to ctpy A of USD, net calculation is paid to ctpy B
Interest Rate Swap Currency Swap (FR)
34
Types of swaps
Interest rate swaps The most common type of swap is a “plain Vanilla” interest rate swap. It is the exchange of a fixed rate
loan to a floating rate loan. The life of the swap can range from 2 years to over 15 years. The reason for
this exchange is to take benefit from comparative advantage. Some companies may have comparative
advantage in fixed rate markets while other companies have a comparative advantage in floating rate
markets.
Currency Swaps
A currency swap involves exchanging principal and fixed rate interest payments on a loan in one currency
for principal and fixed rate interest payments on an equal loan in another currency. Currency swaps entail
swapping both principal and interest between the parties, with the cash flows in one direction being in a
different currency than those in the opposite direction.
Credit Default Swaps

A credit default swap (CDS) is a contract in which the buyer of the CDS makes a series of payments to
the seller and, in exchange, receives a payoff if an instrument - typically a bond or loan - goes into default
(fails to pay).
Total Return Swaps A total return swap is a swap in which party A pays the total return of an asset, and party B makes periodic
interest payments. The total return is the capital gain or loss, plus any interest or dividend payments. Note
that if the total return is negative, then party A receives this amount from party B.
An equity swap is a contract where a set of future floating rate such as LIBOR cash flows are exchanged
Equity Swap against cash flows based on the performance of either a share of stock or a stock market index.
A commodity swap is an agreement whereby a floating (or market or spot) price based on an underlying
Commodity Swap commodity is exchanged for a fixed price over a specified period
35
Exiting a Swap Agreement
Sometimes one of the swap parties needs to exit the swap prior to the agreed-upon termination date. There
are four basic ways to do this:
1. Buy Out the Counterparty

Just like an option or futures
2. Enter an Offsetting Swap
contract, a swap has a calculable
market value, so one party may For example, Company A from the
terminate the contract by paying the interest rate swap example above
other this market value. However, could enter into a second swap, this
this is not an automatic feature, so time receiving a fixed rate and paying
either it must be specified in the a floating rate
swaps contract in advance, or the
party who wants out must secure the
counterparty's consent.
4. Use a Swaption
3. Sell the Swap to Someone Else
Because swaps have calculable A swaption is an option on a swap.
value, one party may sell the contract Purchasing a swaption would allow a
to a third party. As with Strategy 1, party to set up, but not enter into, a
this requires the permission of the potentially offsetting swap at the time
counterparty they execute the original swap. This
would reduce some of the market
risks associated with Strategy 2
36
Trade Life Cycle
Product Structure Trade Life Cycle
Most of the Swap contracts

are non-standardized and hence
they are associated with risk. Buyer Seller
Most of the swaps are

entered in “over the counter”
(OTC) market.
Contract Date Contract Agreement OTC
Notional amount is never

exchanged between
counterparties.
Date of Interval Net Cash flow settled
The five generic types of
swaps, in order of their
quantitative importance, are:
interest rate swaps, currency Contract End
swaps, credit swaps, commodity Net Cash flow settled
Date
swaps and equity swaps.
37
Summary
Last but not least
Derivative instruments have been a feature of modern financial

markets for several decades. They play a vital role in managing the risk
of underlying securities such as bonds, equity, equity indexes, currency,
short-term interest rate asset or liability positions. In the commodity
markets they have, in general, been around for a great deal longer.
Like discussed before, Derivatives are used for risk mitigation and
control and are widely used by Hedgers and speculators to gain control
of market uncertainty and make profits on favorable speculations.
Derivatives are major part of alternative investments portfolios.
So far we have covered in this session a „brief‟ about „Derivatives‟ with simple examples
References:
- Investopedia
- Wikipedia
38
Thank You

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Derivatives

Overview of Derivatives contracts Risk and Hedging Vs Speculation

Introduction to Forward Contracts

Introduction to Futures Margin Account

Introduction to Options Options Value and Product

Introduction to Swaps Types of Swaps

Bullion Securities Interest Exchange Currency Precious Commodities Index

What do the derivatives do?

Derivatives are tools for transferring risk

Exchange Traded Derivatives

Types of derivative contracts

Exchange Traded Over The Counter

Futures Options Swaps Forwards Options

Commodity Commodity Options with Commodity swap Commodity Gold Option

 Derivatives are used to transfer risk. Hedging is the most

 Derivatives can be compared to an insurance policy. As

 Speculate and make a profit if the value of the underlying

There is upside risk and there is downside risk as well.

Financial risks can be categorized as below:

Credit Risk Market Risk Liquidity Risk

Liquidity Risk Operational Risk Systematic Risk

Hedging is a method for reducing risk where a combination of assets are

Individuals and institutions may also look for arbitrage opportunities, as

Hedged Item Hedging Instrument

Company must receive EUR Bank buys 1,000,000 EUR

 Exposure to FX risk: If FX rate is unfavorable in 3

Players Counter Parties

Following are basic features of a forward contract

Forwards traded on OTC hence it is unregulated market

Participants must negotiate rates and prices

Prices depend on credit risk and relationship

Custom made product may be difficult to exit

There will be one delivery date

Credit risk of counterparty may be huge

There is no margin system.

Long forward Payoff Short forward Payoff

Product Structure Trade Life Cycle

Forwards are entered in “over Contract Date Contract Agreement OTC

Deliverable forwards: Goods

Definition Contract Terms

 Long: The party agreeing to buy the underlying asset in

 Delivery Date: Date on which Futures contract is settled

 Underlying asset: Asset which is exchanged by one

 Spot Price: Price at which underlying asset is traded or

Following are basic features of a futures contract

Pricing is extremely efficient. No negotiations.

Prices are the same for all.

Delivery is realized several days after maturity.

There is no credit risk.

Margin system may be expensive.

Future Price Future Price

Traded on an organized exchange Over The Counter in nature

Standardized contract terms Customized contract terms

More liquid Less liquid

Requires margin payments No margin payment

Follows daily settlement Settlement happens at end of period

Prime Broker Exchange

Places order Executes order

Net Settlement Daily

What is an Option contract?

Call Option Put Option

American style European style

Strike Price Strike Price