Financial Instruments & Derivatives Flashcards
3 Types of Financial Instrument
COD
C-cash
O-ownership interests
D-derivative contracts
Derivative (Investment)
Use excess capital to buy stock options on the market
An increase in stock value means the option will go up
Lower investment amount means greater return
Derivative (Arbitrage)
Entering into potentially profitable transactions in separate markets without significant risk of loss
Derivative (Hedge)
the use of a derivative to reduce/eliminate risk as a result of an asset or liability on the financial statements or a future transaction
You’re covered if the price goes up but if the price goes down you have to pay out and miss out on the favorable gain
4 Properties of a derivative
NUNS
N- No net investment (small or none)
U- Underlying amount-what affects the cost of the units
N-Notional amount- number of units
S- Settlement-can be settled in a net amount paid out
Option Contract (Derivative)
You have the right but no obligation to purchase/sell in the future
Put Option-right to sell shares
Call Option-right to acquire shares in the future
Futures Contract (Derivative)
Right and obligation to purchase/deliver foreign currency/goods in the future at a price set today
Forward Contract (Derivative)
Right and Obligation to buy or sell a commodity at a future date for an agreed-upon price
Interest Rate/ Foreign Currency Swap (Derivative)
Exchange of cash flows between two parties at a period in the future
Fair Value Hedge
Acquired to hedge (go against) a recognized asset or liability or a firm purchase commitment
Gain or Loss reported in income from continuing operations (Income Statement)
Should be offset by a gain or loss on the hedge
Used against value of inventory, fixed income investment, fixed rate debt obligation, firm commitment
Cash Flow Hedge
Acquired to hedge against a forecasted future transaction
Gain or Loss on OCI BS
Nothing included in net income until the forecasted activity happens
