Professional Documents
Culture Documents
Ch01 Web Extension 1A Show
Ch01 Web Extension 1A Show
Web Extension 1A
An Overview of Derivatives
Topics in Web Extension
Overview of derivatives
Forward contracts
Futures contracts
Options
Swaps
Forward Contracts
2 parties to contract, each with a basic position:
One party is “long” (buy). Obligates party to buy the
underlying asset at some fixed price at a specified date in
the future.
One party is “short” (sell). Obligates party to sell the
underlying asset at some fixed price at a specified date in
the future.
Terms
Forward price
Delivery date (expiration date)
Forward contracts are common for currencies.
Hedging Risk with Forward
Contracts
US wine importer might plan on purchasing French
wine with euros in the fall. Could lock in the
currency exchange rate for the fall by taking a long
position in a euro currency forward contract.
US computer manufacturer might plan on selling
computers to German company in fall, with the
payment in euros. Could lock in exchange rate by
taking a short position in euro forward contract.
Both parties have reduced risk by locking in the
exchange rate.
Problems with Forward
Contracts
Forward contracts are made directly between
two parties, so there is the possibility of
default (although banks often are one of the
parties in each transaction, in effect acting as
“middlemen”).
Forward contracts are often designed for a
specific need, so there is not a standardized
contract, which makes it difficult to have a
secondary market.
Futures contract solve these problems.
Futures Contracts
Similar to forwards, except:
Marking-to-market
Many more assets- agriculture, livestock,
metals, indexes, currencies, interest rates,
energy
Standardized contracts that trade on
exchanges, such as CBOT
Options
Basic Positions
Call / Put
Long / Short (writer)
Terms
Exercise Price
Expiration Date (can let expire unexercised)
Assets- Stocks, indexes, currency, and futures
CBOE
Swaps
Two parties agree to “swap” some
particular obligation (usually associated
with debt)
Swap payments in one currency for
payments in another currency
Swap floating-rate payments for fixed-rate
payments