P-7 Derivatives Summary (IA1 Valix) PDF

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P-7 DERIVATIVESEXAMPLES OF DERIVATIVES:1. Interest rate swap 2. Forward contract 3. Futures contract 4. OptionInterest rate swap – a contract whereby two parties agree to exchange cash flows for future interest payments based on a contract of loan. Contract of loan = primary FI Interest rate swap = ...

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P-7 DERIVATIVES

EXAMPLES OF DERIVATIVES: 1. 2. 3. 4.

Interest rate swap Forward contract Futures contract Option

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“stand alone” derivatives Derivative financial Instruments separate from primary FIs Would not exist in their own right but have been created solely to hedge against financial risks

Interest rate swap – a contract whereby two parties agree to exchange cash flows for future interest payments based on a contract of loan. • Contract of loan = primary FI • Interest rate swap = derivative FI Forward contract – an agreement between two parties to exchange specified amount of commodities, security or foreign currency on a specified date in the future at a specified price or exchange rate. “Simply stated, it is a commitment to purchase or sell a specified commodity on a future date at a specified price. ” Futures contract – same with forward contract except that it is traded in a futures exchange market in much the same manner as debt & equity securities being traded in stock markets. It is a private contract between two parties who know each other very well. It is a standard contract traded in a futures exchange market & one party will never know who is on the other side of the contract • All cash settlements are made through the exchange market. Option – a contract that gives the holder the right (NOT OBLIGATION) to purchase o sell an asset at a specified price during a definite period at some future time. • •

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There are 2 options: 1. Call option – right to purchase an asset (BUYER) 2. Put option – right to sell an asset (SELLER) It must be paid for This requires an initial small payment (OPTION PREMIUM)...