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Swaps& OPtions (FM)
Swaps& OPtions (FM)
A swap is an agreement to exchange cash flows at specified future times according to certain specified rules. Example: Currency Swap Interest Rate Swap
Currency Swaps
It involves exchanging principal and interest payments in one currency for principal and interest payments in another currency. A currency swap agreement requires the principal to be specified in each of the two currencies. The principal amount is usually exchanged at the beginning and at the end of the life of the swap.
Options Contract
There are two main types of options contract: Call Option Put Option A call (put) holder has the right but not the obligation to buy (sell) the underlying asset at a certain date for a certain price. The specified in the contract is known as expiration date or maturity date. The price specified in the contract is known as exercise price or strike price .
Options Contract
These options can be either European American European options can only be exercise at maturity, whilst American options can be exercised at any time prior to & at maturity. European options are easily to analyze as compare to American options.
Call Options
The purchaser of a call option is hoping that the stock price will increase, Consider situation of an investor who buys a European call option with a strike price of $100 to purchase 100 shares. Suppose current stock price is $98, expiry date of option is 4 month and the price of an option to purchase one share is $5. the initial investment is $500. Option is European so it can only be exercised at expiry date. If the stock price on this date is less than $100, the investor will clearly chose not to exercise. If the stock price is above $199 on the expiration date the option will be exercised. Now suppose that stock price is $115. by exercising the option the investor is able to buy 100 shares for $100 per share. If the shares are sold immediately the investor makes a gain for $15 per share.
Put Options
The purchaser of a put option is hoping that the stock price will decrease. Consider an investor who buys a European put option to sell 100 shares with a strike price $70. Suppose that the current price is $65, the expiration date of the option is in 3 months, and the price of option to sell one share is $7. the initial investment is $700. Because the option is European it will be exercised only if the stock price is below $70 on the expiration date. Suppose that the stock price is $55 on this date. The investor can buy 100 shares for $55 per share and under the terms of put option, sell the same shares for $70 to realize the gain of $15 per share.