Introduction to Derivatives
At this point of the course, we have all been introduced to the basic investment instruments such as bonds and stocks. Now it’s time for us to make things a little bit more interesting. You may or may not have heard the term derivative, however it’s the most important term in the investment world today. Derivatives are a financial contract between two parties whose value is derived from an underlying asset. The underlying asset can be a financial instrument such as a stock or a bond, or it can be a commodity such as gold, silver, wheat and crude oil etc. There are two types of derivatives options and futures (sometimes also called forwards).
Over the counter markets (OTC)
Over the counter markets are also known as off-exchange. Trading takes place between two parties directly without involving an exchange market. The major difference in these two types of transactions is that when a transaction is facilitated by an exchange the liquidity of the asset is much higher than it is if it takes place on OTC markets. The exchanges also mitigate the default risk from both parties and also provides transparency regarding the price of the asset traded, however in OTC markets the price is usually not disclosed to public.
Common Features
All derivatives have some common features in all of them. Derivatives is a contractual agreement between two parties known as counterparties. The agreement consists of the rights that each party acquires upon signing the contract. The buying and selling procedure is the same as in any other buying or selling decision. Sellers try to sell for the highest possible price and buyers try buying for the lowest possible price.
All derivatives have an expiration date, both parties must fu...
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...r a lower and selling it in another market for a higher price. By doing this an investor locks a certain amount of profit with having minimal or no risk.
Call Option Put Option
Buyer (Long Position) Pays premium to the writer and acquires the right to buy the underlying asset a predetermined price.
Expects the price of the asset to rise. Pays premium to the write and acquires the right to sell an underlying asset at a predetermined price.
Expects the price of the asset to fall.
Writer (Short Position) Receives premium from the buyer and has the obligation to sell the underlying asset at the predetermined price.
Expects the price of the underlying asset to remain the same or fall. Receives premium from the buyer and has the obligation to buy the underlying asset at the predetermined price.
Expects the price of the underlying asset to rise or remain the same.
...ocks at a low value, and gain even more money when these securities appreciate in value.
What is code section relating to the possibility to defer any realized gain if an exchange of property transaction had occur?
(ii) A physical substance, which is interchangeable with another product of the same type, which investors buy or sell, usually through futures contracts. The price of the commodity is subject to supply and demand. Risk is actually the reason exchange trading of the basic agricultural products began. For example, a farmer risks the cost of producing a product ready for market at sometime in the future because he doesn't know what the selling price will be. (European Merchant exchange)
It is also known as a process by which big financial institutions (banks, Insurance companies) and different stock brokers protect themselves from harsh client grievances.
One of the most important of these is the convertible bond, which can be exchanged for common shares at specified prices that may gradually rise over time. Such a bond may be used as a financing device to obtain funds at a low interest rate during the initial stages of a project, when income is likely to be low, and encourage conversion of the debt to stock as earnings rise. A convertible bond may also prove appealing during periods of market uncertainty, when investors obtain the price protection afforded by the bond segment without materially sacrificing possible gains provided by the stock feature; if the price of such a bond momentarily falls below its common-stock equivalent, persons who seek to profit by differentials in equivalent securities will buy the undervalued bond and sell the overvalued stock, effecting delivery on the stock by borrowing the required number of shares (selling short) and eventually converting the bonds in order to obtain the shares to return to the lender.
known as fuel hedging for long-term strategies, which is a tool for protecting the company from
The first scenario is that Bo Broker Company will accept a non-interest bearing or unsecured negotiable note that is payable over the life of the related
On this stage the there is an assignment of rights under export & offtake contracts between the SPV and the facility agent (big international bank).
to give up a large percentage of the profit in a good year. Or maybe both sides
Second: The estimated price for the transfer of an asset or liability between identified knowledgeable and willing parties that reflects the respective interests of those parties (IVS 2013).This price takes into consideration what is the right price of commodity without any hidden agendas in the price, as opposed to Investment Worth, Fair value is calculated as the price of the end product which is fair to both suppliers and buyer. Also opposed to market value, here the supplier or buyer might not be willing to buy or sell at this price but other factors such as government policies might force them to sell and buy at this price. This price is mostly set by government and other regulatory bodies to protect consumers from monopoly market, and protect suppliers from
Selling receivable before its maturity date to financial institutions or factoring companies is one of the company’s strategies to obtain an immediate cash and make company’s operating cycle becomes shorter. For providing this service, the financial institution or factoring company requires a compensation such as interest, commission fee, and other requirements to secure the transaction. Consequently, the amount of money received by the company, as a seller or transferor, less than the face value of the account receivable, or it purchases at discount. Selling receivable transaction can be executed either without recourse in which the transferor has no obligation for uncollectible receivables or with recourse in which the transferor has full responsibility for any uncollectible receivables.
In order to truly simulate the characteristics of a short-term tax-exempt security, the TOB sponsor has to provide a way for investors to liquidate their investment at par value. This is accomplished by giving the investor the right to tender (or put) the security to the remarketing agent at par value plus accrued interest at regular intervals. These intervals are based on investor demand (Merrill’s program generally sets them at one week).
Under this type of factoring the factor has the right to demand the payment from the seller in case of default by the buyer. This means that the factor does not take the risk associated with receivables. The factor is entitled to recover the amount paid in advance from the client. In this case , the factor charges the customer for maintain the sales ledger and other debt collection services. He charges interest on the amount for the period drawn by the client .
Differential calculus is a subfield of Calculus that focuses on derivates, which are used to describe rates of change that are not constants. The term ‘differential’ comes from the process known as differentiation, which is the process of finding the derivative of a curve. Differential calculus is a major topic covered in calculus. According to Interactive Mathematics, “We use the derivative to determine the maximum and minimum values of particular functions (e.g. cost, strength, amount of material used in a building, profit, loss, etc.).” Not only are derivatives used to determine how to maximize or minimize functions, but they are also used in determining how two related variables are changing over time in relation to each other. Eight different differential rules were established in order to assist with finding the derivative of a function. Those rules include chain rule, the differentiation of the sum and difference of equations, the constant rule, the product rule, the quotient rule, and more. In addition to these differential rules, optimization is an application of differential calculus used today to effectively help with efficiency. Also, partial differentiation and implicit differentiation are subgroups of differential calculus that allow derivatives to be taken to more challenging and difficult formulas. The mean value theorem is applied in differential calculus. This rule basically states that there is at least one tangent line that produces the same slope as the slope made by the endpoints found on a closed interval. Differential calculus began to develop due to Sir Isaac Newton’s biggest problem: navigation at sea. Shipwrecks were frequent all due to the captain being unaware of how the Earth, planets, and stars mov...
As compensation they charge a fee for this agreement. Agent and Brokers also differ from a merchant wholesaler because they do not own goods and services that they buy and sell. Agents works closely with buyers and sellers with more lasting businesses (Kotler & Keller, 2012). An example of an agent with this representation is a real estate agent who enters into a contract to sell a house or business to a consumer. The relationship exists until the need is met and at this point the agent collects a pre-determined