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56 Derivate Markets and Instruments (Derivate Markets and Instruments…
56 Derivate Markets and Instruments
Derivate Markets and Instruments
Definition
Contracts
Derives its performance from the performance of an underlying asset.
Four main derivatives
Future contract
standarized
trades on an future exchange
the daily settlement for gains and losses
Forward contract
private agreement
Swap contract
a series of forward contracts
default risk
Option contract
The owner has the right, but not the obligation to conduct a transaction.
long position need to pay option premium
Classification
according to contract features
Forward commitment
Contingent claim
according to trading place
Exchange-traded
Over-the-counter (OTC) traded
Advantage & disadvantage of derivatives
Advantage
Disadvantage
Four main derivative products
Forward
classification
Commodity forward contract
Financial forward contract
purpose
hedge risk
speculation
settling a forward contract
at expiration
physical settlement
cash settlement
setting a forward contract
prior to expiration
offsetting with a different party
offsetting with the original party
LIBOR, Euribor, and FRAs
An FRA can be viewed as a forward contract to borrow/lend money at a certain rate at some future date.
Settlement
settle in cash, but no actual loan is made at the settlement date
Future
settling
deliverable contracts
cash settlement
difference with forward
risk control of future contract
margin
initial margin
maintenance margin
variation margin
difference between equity margin
daily price limit
marking to market
a daily settlement process
Swap
similarity with forward
plain vanilla interest rate swap
paying fixed and receiving floating
Option
Call option
Put option
Prices
option premium
exercise price
Credit default swaps (CDS)
Risk free arbitrage
equivalent assets or combinations of assets sell for two different prices
sell high, buy low