Intro Fdrm
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Transcript of Intro Fdrm
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Introduction
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What is a Derivative?
A derivative is an instrument whose value
depends on, or is derived from, the value
of another asset.
Examples: futures, forwards, swaps,
options, exotics
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Underlying Assets
Commodities including grain, coffee beans,orange juice;
Precious metals like gold and silver;
Foreign exchange rates or currencies;
Bonds of different types, including medium tolong term negotiable debt securities issued bygovernments, companies, etc.
Shares and share warrants of companiestraded on recognized stock exchanges and
Stock Index Short term securities such as T-bills; and
Over- the Counter (OTC)2 money marketproducts such as loans or deposits.
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Participants
Hedgers:They use derivatives markets to reduce oreliminate the risk associated with price of an asset.Majority of the participants in derivatives marketbelongs to this category.
Speculators:They transact futuresand options
contracts to get extra leverage in betting on futuremovements in the price of an asset. They canincrease both the potential gains and potential lossesby usage of derivatives in a speculative venture.
Arbitrageurs:Their behavior is guided by the desire to
take advantage of a discrepancy between prices ofmore or less the same assets or competing assets indifferent markets. If, for example, they see the futuresprice of an asset getting out of line with the cashprice, they will take offsetting positions in the twomarkets to lock in a profit.
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Financial Weapons of Mass Destruction??Year
Amount (USD in bn) Country Organization Key Player Instruments
2008 USD 9 bn USA Morgan Stanley Howie Hubler credit default Swaps
2008 7.1 France Societe Generale Jerome Kerviel Equity Index Futures
2006 6.5 Canada Amaranth Advisors Brian Hunter Natural Gas Futures
1998 4.6 USA
Long Term Capital
Management John Meriwether
Interest
rate/equity/currency
futures
1996 2.6 Japan Sumitomo Corporation Yasuno Hamanaka Copper Futures
2008 BRL 4.62 bn brazil Aracruz
Isac Zagury, Rafael
Sotero FX options
2011 USD 2 bn UK UBS Kweku Adoboli
Equities, ETF and Delta
1
1994 1.7 USA Orange County Robert Citron
Interest rate
derivatives
2006 1.9 Austria Bawag Bank
Helmut Elsner,
Wolfgang Flottl,Johann Zwettler
Foreign ExchangeTrading
1993 DEM 2.63 bn Germany Metallgesellschaft Heinz Schimmelbusch Oil Futures
2008 HKD 14.7 bn China CITIC Pacific Frances Yung
Foreign Exchange
Trading
2008 USD 1.8 bn USA Deutsche Bank Boaz Weinstein Derivatives
1995 1.32 UK Barings Bank Nick Leeson Nikkei Futures5
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Applications
Management of risk
Efficiency in trading
Speculation
Price discovery Price stabilization function
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CLASSIFICATION OF DERIVATIVES
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Forward Contract
agreement between two parties to buy or
sell an asset at a specified point of time in
the future
the price which is paid/ received by the
parties is decided at the time of entering
into contract
It is the simplest form of derivative contract
mostly entered by individuals in day to
days life.
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One of the parties to a forward contract
assumes a long position (buyer) and
agrees to buy the underlying asset at a
certain future date for a certain price.
The other party to the contract known as
seller assumes a short position and agrees
to sell the asset on the same date for the
same price.
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The specified price is referred to as the
delivery price.
The contract terms like delivery price and
quantity are mutually agreed upon by the
parties to the contract.
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Futures Contracts
Agreement to buy or sell an asset for a certain
price at a certain time
Similar to forward contract
Whereas a forward contract is traded OTC, a
futures contract is traded on an exchange
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Exchanges Trading Futures
CME Group (formerly Chicago Mercantile
Exchange and Chicago Board of Trade)
NYSE Euronext
BM&F (Sao Paulo, Brazil) TIFFE (Tokyo)
and many more (see list at end of book)
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Futures Contract Standardized
Terms
1. Quantity
2. Quality
3. Expiration months
4. Delivery terms
5. Delivery differentials
6. Delivery dates
7. Minimum price fluctuation
8. Daily price limits
9. Trading days and hours
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Forward Versus Futures
COMPARISON FORWARD FUTURES
Trade on organized exchanges No Yes
Use standardized contract terms No Yes
Use associate clearinghouses to guarantee contract fulfillment No Yes
Require margin payments and daily settlements No Yes
Close easily No Yes
Regulated by identifiable agencies No Yes
Any quantity Yes No
Any product Yes No
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Options An option is the right, but not the
obligation, to buy or sell something at a
stated date at a stated price
A call option is an option to buy a certain
asset by a certain date for a certain price
(the strike price)
A put option is an option to sell a certain
asset by a certain date for a certain price
(the strike price)
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American vs European Options
An American option can be exercised at
any time during its life
A European option can be exercised only
at maturity
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Options vs Futures/Forwards
A futures/forward contract gives the holder
the obligation to buy or sell at a certain
price
An option gives the holder the right to buy
or sell at a certain price
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SWAPS
A swapcan be defined as a barter orexchange.
a swap is an agreement between two or
more parties to exchange stream of cash
flows over a period of time in the future.
The parties that agree to the swap are
known as counter parties
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Interest rate swapswhich entail swappingonly the interest related cash flows
between the parties in the same currency
Currency swaps: These entail swappingboth principal and interest between the
parties, with the cash flows in one direction
being in a different currency than the cash
flows in the opposite direction.
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How to Avoid Derivative Disasters?
Set up controls to ensure derivatives are being used for
their intended purpose.
Risk limits should be set and the activities of traders
should be monitored daily to ensure that these risk limitsare adhered to.
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Indian Derivatives Market
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Regulations
Based on the L.C. Gupta Committee
Report, and the J.R. Varma Committee
Report.
It is mostly consistent with the IOSCO5
principles and addresses the common
concerns of investor protection, market
efficiency and integrity and financial
integrity
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Products traded in Derivatives Segment in BSE
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Products traded in F&O segment of NSE
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Index Futures
Turnover (RsCr), 2000-01,
2365
Turnover (RsCr), 2001-02,
21483
Turnover (RsCr), 2002-03,
43952
Turnover (RsCr), 2003-04,
554446
Turnover (RsCr), 2004-05,
772147
Turnover (RsCr), 2005-06,
1513755
Turnover (RsCr), 2006-07,
2539574
Turnover (RsCr), 2007-08,
3820667
Turnover (Rs
Cr), 2008-09,3570111
Turnover (RsCr), 2009-10,
3934388
Turnover (RsCr), 2010-11,
4356754
Turnover (RsCr), 2011-12,
3577998
Turnover (RsCr), , 0
Turnover (Rs Cr)
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Stock Futures
Turnover (RsCr), 2000-01, 0
Turnover (RsCr), 2001-02,
51515
Turnover (RsCr), 2002-03,
286533
Turnover (RsCr), 2003-04,
1305939
Turnover (RsCr), 2004-05,
1484056
Turnover (Rs
Cr), 2005-06,2791697
Turnover (RsCr), 2006-07,
3830967
Turnover (RsCr), 2007-08,
7548563
Turnover (RsCr), 2008-09,
3479642
Turnover (RsCr), 2009-10,
5195246
Turnover (Rs
Cr), 2010-11,5495756
Turnover (RsCr), 2011-12,
4074670
Turnover (RsCr), , 0
Turnover (Rs Cr)
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Index Options
Column1,
2000-01, 3765
Column1,2001-02, 9246
Column1,2002-03,
52816
Column1,2003-04,121943
Column1,
2004-05,338469
Column1,2005-06,791906
Column1,2006-07,1362110
Column1,2007-08,3731501
Column1,
2008-09,8027964
Column1,2009-10,18365365
Column1,2010-11,
22720031
Turnover (Rs Cr)
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Stock Options
Series 1,2000-01,
25163
Series 1,2001-02,100131
Series 1,2002-03,217207 Series 1,
2003-04,168836
Series 1,2004-05,180253
Series 1,2005-06,193795
Series 1,2006-07,
359136Series 1,2007-08,229226
Series 1,2008-09,506065
Series 1,2009-10,1030344
Series 1,2010-11,977031
Turnover (Rs Cr)
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Source: Bank of International Settlement
Global Perspective
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Foreign Exchange Contracts
Column1,Dec-13,49181
Column1,Jun-14,53153
Column1,Dec-14,57796
Column1,Jun-15,64698
Column1,Dec-15,63349
y = 21.849x - 827495R = 0.9131
USD Bn
Source: BIS
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Interest Rate Contracts
Series 1, Dec-13, 449875
Series 1, Jun-14, 451831
Series 1, Dec-14, 465260
Series 1, Jun-15, 553240
Series 1, Dec-15, 504098
USD Bn
Source: BIS
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Equity-linked Contracts
Series 1, Dec-13, 5937
Series 1, Jun-14, 6260
Series 1, Dec-
14, 5635
Series 1, Jun-15, 6841
Series 1, Dec-
15, 5982
USD Bn
Source: BIS
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Commodity Contracts
Column1,Dec-13, 2944
Column1,Jun-14, 2852
Column1,Dec-14, 2922
Column1,Jun-15, 3197
Column1,Dec-15, 3091
USD Bn
Source: BIS
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Credit Default Swaps
Series 1, Dec-13, 32693
Series 1, Jun-
14, 30261
Series 1, Dec-
14, 29898
Series 1, Jun-15, 32409
Series 1, Dec-15, 28633
USD Bn
Source: BIS