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Derivatives Case

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Derivate: a financial instrument whose value depends on the values of other, more basic, underlying variables.

*Forward contracts: agreement to buy or sell an asset at a certain future time for a certain price (OTC). Spot contract: today.

Payoff →Long pos: ST- K (buy) ; short pos: sell K-ST K=delivery price ST: price of asset at contract maturity

*Future contract: (same fc)normally trade exchange market. Standized contract. Mechanism of guarantee the contract will be honoured.

*Options: (both markets)right that can be done or not (call=buy the underlying asset certain date certain price) (put=sell). Price= exercise/strike price date:expiration/maturity. Am(larger): any time. Eur: just on date. Whereas its costs nothing to enter into a forward or future contract, there is a cost acquiring op

*Speculators: try to bet on the future directions of a market variable. When spe uses futures, the potential loss/gain is very large. Op: no matter how bad thing get, the speculator's loss is limited to pre-paid

*Arbitrageurs:try to take offsetting pos in 2 or more instrument to lock in a profit.


Specification of a future contracts: asset (commo: quality, grade of acceptance), contract size( amount, large unable to inv small exposure or wish small spec position; small= +costs), delivery arrangement (where, transportation cost), delivery month (when, can be whole m), price quotes(how prices will qu), price limits and position limits. As the delivery day is approached the, future price converge to spot price.

Operation with margins.

*ETM: market where individuals trade standardized contracts that have been defined by the exchange.

Organize the trading so that contract default are avoided.

-Daily settlement:broker required inv deposit fundsi in margin account. Contract entered=initial margin. At the end of each trading day, the margin account is adjusted to reflect the investor's gain/loss.

Invertor 1-> (broker 1->broker 2)-> investor 2 (vic)

The investor is entitled to withdraw any balance in the margin account in excess of the initial margin. To ensure that the balance in the margin account never becomes negative a maintenance margin, which is somewhat lower than the initial margin, is set. Fall below m.m., margin call, is expected to top up to i.m by the end of the next day. The extra funds deposited are known as variation margin. No vm, broker closes out the position.

Further details: most brokers pay investors interest on the balance in a margin account. The balance in the account doesn't, therefore, represent a true cost, provided that the interest rate is competitive with what could be earned elsewhere. To satisfy the initial margin requirements, but not subsequent margin call, an investors usually deposit secuties with the brokers. Whereas a forward contract is settle at the end of its life, a future contract is settled daily. At the end of each day, the investor gains/losses is added to the margin account, bringing the value of the contract back to zero. Margins are determined by the variability of the price of the underlying asset. Margins req. are the same on short and long position.

-Clearing house: intermediary in fut. It guarantees the performance of the parites to each trans. Keep track of all transaction that take place duringa day, so that it can calculate the net position of each of its members.The main purpose of the margining system is to ensure that funds are available to pay traders when they make a profit.

OTM : important alternative to exchange, larger that ETM. It is a telephone and computer-linked network of dealers. Don't have a contrat specified by an exchange. Markets are free to negotiate any mutually attractive deal. Usually between two financial institutions or between a financial institution and on of its clients. Financials institutions oftn act as amarket markers for the more commonly traded instruments. This means that they are always prepared to quote both a bid price and a offer price. (price at which they are prepared to sell/buy). Disadvantage: credit risk

-Collateralization:might involve the transaction to being valued each day.

-Clearing house in OTC: traditional way→ series of bilateral agreements between participants.->collaterial, credit risk reduction, transparent.


-Settlement price: before the end of the day's trading session

-Trading Volume:number of contracts trade. TV can be greater than both the beginning-of-day and end-of-day open interest, which indicates many traders who entered into pos duing the day close befor end.

-Open interest: number of contracts outstanding (long ps=short ps)

-Patterns of Future Price: markets where the f.p. is an increasing (decreasing) function of the time to maturity are known as normal markets (inverted market).

DELIVERY:Vast majority don't lead to delivery. The reason is that traders choose to close out their position prior to the delivery period specified. Closing out a pos means entering



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