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CHAPTER 2 CONCEPTS OF DERIVATIVES - Coggle Diagram
CHAPTER 2
CONCEPTS OF DERIVATIVES
What is Derivative?
financial instruments with value derived from its underlying assets (-SC 2002)
Types of Derivatives
Forward
to buy & sell security at a specified price, to be delivered in the future
referred to as a privately-negotiated agreement
Options
provides the buyer the right, not obligation to purchase/sell an underlying asset at agreed price in a specified time by paying a premium to the seller
Futures
third part needed, namely the clearing house which serves as a buyer for every seller & vice versa
to buy & sell an asset in future for a price determined today
Swap
a private agreement to swap/exchange a specified security/cash flow
due to the need of international business
What is the Purpose of Derivatives Market?
Price discovery
derivative markets are able to reveal information about future cash market prices
enable investors to make better investment & consumption decisions
Hedging mechanism
participants of future market use derivative contract to substitute the cash market transaction
to manage price risks systematically
price risks: the adverse price movements in future that will affect their exposure in the cash market
Who is the Major Participant?
Hedgers
physical owners of the underlying asset
use derivative instruments to protect the risk exposure in cash market
as a forum to manage unfavorable price movements
Speculators
traders who make profit from the price volatility
exposed to high risk as they hold the contract more than one week
risk exposure depends on their holding objective
Exchange-Traded VS Over-the-Counter
Exchange-Traded
not centralized
high risk
no guarantee of performance
not transparent
Over-the-Counter
commission-regulated
standardized contract
guaranteed by clearing house