Financial Instruments Derivatives Ppt MBA FINANCE
-
Upload
babasab-patil-karrisatte -
Category
Documents
-
view
227 -
download
1
Transcript of Financial Instruments Derivatives Ppt MBA FINANCE
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
1/24
Financial Instruments
Money & Banking
-Derivatives
PRESENTED BY:-BABASAB PATIL
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
2/24
Content Outline1. Introduction
2. What is a derivative?
3. Reasons to use derivatives4. Concepts to understand
5. Futures
6. Forwards7. Options
8. Swaps
9. Questions
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
3/24
Introduction (I)In the financial marketplace some instruments are regarded as f u n d a m e n t a l s ,while others are regarded as d e r i v a t i v e s .
Financial Marketplace
Derivatives Fundamentals
Simply another way to catagorize the diversity in the FM*.
*Financial Market
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
4/24
Financial Marketplace
Derivatives Fundamentals
Stocks Bonds Etc.
Futures Forwards Options Swaps
Introduction (II)
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
5/24
What is a Derivative? (I)
Options
Swaps
ForwardsFuturesThe value of thederivative instrument is
DERIVED from theunderlying security
Underlying instrument such as a commodity, a stock, a stock index, an exchange
rate, a bond, another derivative etc..
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
6/24
Options
Swaps
Forwards
Futures
The owner of an options has the O P T I O N to buy or sellsomething at a predetermined price and is therefore more costlythan a futures contract.
The owner of a forward has the O B L I G AT I O N to sell or buysomething in the future at a predetermined price. The differenceto a future contract is that forwards are not s t a n d a r d i z e d .
The owner of a future has the O B L I G AT I O N to sell or buysomething in the future at a predetermined price.
What is a Derivative? (II)
A swap is an agreement between two parties to
exchange a sequence of cash flows.
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
7/24
Reasons to use derivatives (I)
Hedging:
Speculation :
Interest rate volatility Stock price volatility Exchage rate volatility Commodity prices volatility
VOLATILITY
High portion of leverage Huge returns
EXTREMELY RISKY
Derivative markets have attained an overwhelming popularity for a variety of reasons...
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
8/24
Reasons to use Derivatives (II)
Also derivatives create...
a c o m p l e t e m a r k e t , defined as a market in which all identifiable payoffs can be
obtained by trading the securities available in the market*.
and m a r k e t e f f i ci e n c y , characterized by low transaction costs and greater
liquidity.
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
9/24
Concepts to Understand
Short Selling: Short selling is the selling of a security that theseller does not own.
Short sellers assume the risk that they will be ableto buy the stock at a more favorable price thanthe price at which they sold short.
Holding Long Position:
Investors are legally owning a security.
Investors are the legal owners of a security.
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
10/24
Future Contracts (I)
Futures The owner of a future contract has the OBLIGATION to sell orbuy something in the future at a predetermined price.
Scenario: You are a farmer and you know that you will harvest corn in three months from
today on. How can you protect yourself from loosing if corn price happens to drop
until March by using corn forward contracts?
t1/1 3/1
Harvest
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
11/24
Future Contracts (II) You lock into a price by holding a short position in a corn future contract with a
maturity date a little bit longer than the harvest date.
Suppose the price drops...
You either take delivery andlock in a price.
You close out the corn contractand the gain in the futuresmarket will offset the loss in thesport market
A futures contract makes unfavourable price movements less unfavourable and a
favourable price movements less favourable!
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
12/24
Future Contracts (III)
General Rule for Hedgers:
If you are going to sell something in the near future but want to lock in a
secured price, you take a short position.
If you are going to receive/buy something in the future but want to lock in a
secured price, you take a long position.
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
13/24
Future Contracts (IV)
The Role of Speculators:
As the name implies, speculators are involved in price betting and take the risk of
price movements against them.
Assume the following: You, as hedger, believe that prices will raise. Thus, you are convinced that a long
position will benefit you.
Key Word: Zero-Sum-Gain
Large gains due to the concept of leverage
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
14/24
Forward Contracts (I)
Forwards The owner of a forward has the OBLIGATION to sell or buysomething in the future at a predetermined price. The differenceto a future contract is that forwards are not standardized.
A Forward Contract underlies the same principles as a future contract, besides the
aspect of non-standardization. Thus, a detail illustration is not necessary as I already
elaborated in the mechanism of the futures contract.
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
15/24
Options (I)
Options The owner of an options has the OPTION to buy or sellsomething at a predetermined price and is therefore more costlythan a futures.
Some terms to understand:
Call option
Put option
Excersice price / strike price
Option premium
Moneyness (in-the-money, at-the-money, out-of-money)
European vs. American Options
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
16/24
Options (II)
Call Option
Put Option
Write
Purchase
Write
Purchase
The four basic positions:
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
17/24
Options (III)Write & Purchase Call Option:
x
Long Call
Short Call
Value
Stock Price at Expiration
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
18/24
Options (IV)Write & Purchase Call Option:
Profit and Loss
xStock Price at Expiration
Long Call
Short Call
Premium Paid
Premium EarnedZero-Sum-Game
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
19/24
Options (V)Write & Purchase Call Option:
Profit and Loss
Stock Price at Expiration
Long Put
Short Put
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
20/24
Options (VI)Write & Purchase Call Option:
Profit and Loss
Stock Price at Expiration
Long Put
Short PutPremium Paid
Premium Earned
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
21/24
Swaps A swap is an agreement between two parties toexchange a sequence of cash flows.
Swaps (I)
Counterparties
Interest rate swaps
Currency swaps
Phenomenal growth of the swap market
Future and Option markets only provide for short term investment horizon
Traded in OTC markets with little regulations
No secondary market
Market limited to institutional investors
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
22/24
Swaps (II)
A Plain Vanilla Interest Rate Swap:
An interest rate swap is an agreement between two parties to exchange a sequenceof fixed interest rate payments against floating interest rate payments.
Fixed side
Receive-fixed side
Tenor
Notional amount
Terms to understand:
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
23/24
Swaps (III)Example:
5 year tenor; notional amount $1 million; Party A is the fixed side paying 9%, Party Bis the receive-fixed side, paying a LIBOR flat rate
0 1 2 3 4 5
0 1 2 3 4 5
$90,000 $90,000 $90,000 $90,000 $90,000
$90,000 $90,000 $90,000 $90,000 $90,000
Libor*$1m Libor*$1m Libor*$1m Libor*$1m Libor*$1m
Libor*$1m Libor*$1m Libor*$1m Libor*$1m Libor*$1m
Party A
Party B
-
8/2/2019 Financial Instruments Derivatives Ppt MBA FINANCE
24/24
QUESTIONS