FMI week 9 Derivative Markets - Coggle Diagram
FMI week 9 Derivative Markets
a financial contract between two parties which has a payoff
determined by the price of underlying assets
Allow risk to be shared among market participants
interest rate derivatives
are large in size and mostly dealt with OTC
Forward and Future contracts
to buy or sell a
of some asset at
predetermined price and date.
by the short side to specific date and location or
to send cheque with payoff amount.
to precisely meet the need
of future price is
by both parties
profitability is not certain
both parties subject to
when price move adversely
highly customised, difficult to
offset a position
marking to market
for credit risks
must be maintained at acceptable level
gains and losses are paid daily via ASX clearing house, if not margin call will be made
margin requirement may cause cash shortage, force investor liquidate.
Basis risk: ??
options give the buyer
the right, not obligation
to buy/sell financial instrument at a
on or before a
Only long side can get to
when/whether to exercise, put side has to
and gets reversed payoff.
can be exercised only on expiration date T.
can be exercised any time up to T.
futures vs options
futures: both parties face same amount of risk, fair chance to win/lose.
options: give buyer downside price protection and upside potentials.
futures are free, options have
Bonds with options
permit issuers/buyers the
right, not obligation
to change the bond before maturity.
the right to buy the bond from the buyer at fixed strike price before bond maturity.
helps issuers hedge against
declining interest rate
, buy back and replace with low cost debt
Call interest premium
: difference in interest rate between callable and non-callable bonds. higher to compensate investors.
the right to sell the bond back to issuer at fixed strike price before bond maturity.
helps buyer hedge
increasing interest rates
, sell bond and reinvest in higher return project.
The put interest discount:
difference between puttable and nonputtable bonds. lower due to benefit of investor protection.
permits the buyer to
into equity at pre-specified conversion rate on permitted date.
most valuable when share market prices are rising and bond prices are declining.
obtain better financial conditions, diminish liabilities. offer lower interest rate.
: defensive security
tend to be used by smaller firms with high growth rate and more financial leveraged.
two parties agree to exchange payment obligations on two underlying financial liabilities that are
equal in notional principle amount
differ in payment patterns.
interest rate swap
a swap of a series of
fixed interest rate
floating interest rate
two parties swap their interest payment obligations
the principle amount is never actually transferred between counter parties.
: a swap of
two different reference rate
reasons for interest rate swaps
Lower cost of funds
access gained to otherwise inaccessible debt market
Hedge interest rate risk exposures
profit margins locked in on economic transactions
equity swap contract:
swaps floating interest rate to performance of a stock or market index. using Marking to market to reduce credit risks.