Professional Documents
Culture Documents
Derivative 1
Derivative 1
A derivative is a
• Contract
• Underlying asset
• Set of payments
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The underlying may be…...
• foreign currency
• commodities
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Factors driving the growth of derivatives
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Functioning of derivatives.
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Types of derivatives
• Forwards
• Futures
• Options
• Swaps (?) and
• many more exotics!!!!!
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Forwards:
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Futures
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Futures contd…
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Options
Options are of two types- calls and puts. Call give the
buyer the right but not the obligation to buy a
given quantity of the underlying asset, at a given
price on or before a given future date.
Puts give the buyer the right, but not the obligation
to sell a given quantity of the underlying assets at
a given price on or before a given date.
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An option contract is
•To buy/sell
•right but not obligation
•underlying asset
•stated date and price
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Options terminology
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Derivatives Markets
• Exchange traded
– Traditionally exchanges have used the open-outcry
system, but increasingly they are switching to electronic
trading
– Contracts are standard there is virtually no credit risk
• Over-the-counter (OTC)
– A computer- and telephone-linked network of dealers at
financial institutions, corporations, and fund managers
– Contracts can be non-standard and there is some small
amount of credit risk
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Ways Derivatives are Used
• To hedge risks
• To speculate (take a view on the future direction
of the market)
• To lock in an arbitrage profit
• To change the nature of a liability
• To change the nature of an investment without
incurring the costs of selling one portfolio and
buying another
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NSE’ s Derivative Market
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Trading Mechanism
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Turnover: Business growth of futures and options
market: Turnover (Rs. Crores)
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Exchange Traded Vs OTC Derivatives Markets:
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Economic Functions of Derivative Market
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Economic functions cont….
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Forward Contracts
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Forward Price
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Terminology
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Example
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If the rate on 16, Feb 2011 is £1=$1.5
• K=> £1=$1.4359.
• St=> £1=$1.5
• Size of Contract £1 million.
• Calculate the saving?
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If the Spot price after six month is
£1=$1.4??
• Strike Price K=> £1=$1.4359
• Spot Price St => £1=$1.4.
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Futures Contracts
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Examples of Futures Contracts
• Agreement to:
– buy 100 oz. of gold @ US$300/oz. in December
(COMEX)
– sell £62,500 @ 1.5000 US$/£ in March (CME)
– sell 1,000 bbl. of oil @ US$20/bbl. in April
(NYMEX)
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Options…
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Options..Prices of options on Intel, may 2009.
Calls Puts
Strike June July October June July October
Price ($)
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Options..
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Options..
• In this example:
• The investor has obtained at a cost of $115 the
right to buy 100 Intel shares for $22.50 each.
• The other party has received $115 and has agreed
to sell 100 shares of Intel for $22.50 per share.
He is under obligation to sell the said shares.
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Options.. What if October spot price of Intel
is $ 30?
• Call Option payoff = (St-K,0)
• Put option payoff = (k-St,0)
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Options.. What if the October spot price of
Intel is $22.00
• Payoff to investor =???
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Put Options..
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Put Options.. What if July spot price of Intel
is $18??
• Payoff of the Put option = (K-St,0)
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Put option.. What if July Spot price of Intel
is $22.50??
• Payoff to the investor?
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