wk4 Flashcards
why are derivatives important?
-risk management
what must a competent asset manager do?
-recognise and understand risk
-protect against risk known as hedging
-exploit risk known as speculation
evaluate results after allowing for risk
define heding
invest to reduce risk from movements in asset price
-borrower & lender concern = interest rate changes
-commodity producers and buyers concern = price changes
-importers and exporters concern = exchange rate change
a way of hedging is forming diversified portfolio of asset to reduce risk or enter derivates contract premium paid and or profit foregone
define speculation
earn profit for accepting risk or understand potential for gains
-hedgers pay speculators for taking on risk
define arbitrage
-earn riskless, costless profit by trading
define leverage (gearing)
borrow to increase potential return on investment
trader increase risk and return by leverage
What are the two types of ways derivates are traded?
- exchange traded contracts = organised exchange, know parties, guarantees contract
- over the counter = corporate treasures contact each other to negotiate and agree terms contract traded directly between two parties each taking on credit of other
what are derivate instruments?
- contracts derive value from value or return of underlying asset
what are the key contracts of derivate instruments?
-forwards and futures
-options
-swaps
these are the key contracts
what were derivative contracts originally written on?
commodity prices but now can buy contracts from equity prices, bond prices and interest rates
short position
to sell
long position
to buy
forwards and futures
contract to buy or sell asset in future at certain price and time
options
holder rights to buy or sell asset at certain price
swaps
agreement to exchange cashflow at certain prices and times
what is an underlying asset
what type of as is it so for example a stock price or exchange rate
what is a derivative type?
what type of contract is so forward, future swap or option
how can risk be reduced
- insurance
-diversification
-match duration of asset and liabilities
futures, forwards, options and swaps
why are derivatives used?
-to hedge risks
-change nature of liability
-speculate so take view on future direction of market
-change nature of investment
forward contracts
agreement to trade specified asset at specified future time an place at agreed price
what are the basic types of forward contracts
foreign exchange, commodity, FRA
what two parties can forward contracts be created with?
long position = agree to sell in future, expect price to increase in future
short position = agree t sell in future, expect price to decrease
