...FINANCIAL DERIVATIVES (A Future of Indian Financial Market) Dr. Ritu Kothiwal, Associate Professor, BIET, Hyderabad Contact No: 09246193330 Email Id: kothiwal55@gmail.com Mr. Ankur Goel, Research Scholar (Management), Mewar University, GZB. Contact No: 9917745990 Email Id: mrankurgoel@gmail.com. ABSTRACT Among all the innovations that have flooded the international financial markets, financial derivatives occupy the driver's seat. These specialized instruments facilitate the shuffling and redistribution of the risks that an investor faces. Thus aids in the process of diversifying ones portfolio. The volatility in the equity markets over the past years has resulted in greater use of equity derivatives. The volume of the exchange traded equity futures and options in most of the mature markets have seen a significant growth. It goes beyond that the local derivative in the emerging markets have witnessed widespread use of the derivative instrument for a variety of reasons. This continuous growth and development by the emerging market participants has resulted in capital inflows as well as helped the investors in risk protection through hedging. INTRODUCTION AND CONCEPT OF DERIVATIVES: Derivatives are financial contracts whose values are derived from the value of an underlying primary financial instrument, commodity or index, such as: interest rates, exchange rates, commodities, and equities. The International Monetary Fund defines derivatives as "financial...
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...Handbook on Derivatives © Rajkumar .S Adukia B.com (Hons.), L.L.B, AICWA, FCA radukia@vsnl.com/rajkumar@gmail.com 093230 61049/ 093221 39642 www.carajkumarradukia.com If interested in receiving similar technical updates subscribe to carajkumarradukia-subscribe@yahoogroups.com PREFACE Derivatives have changed the world of finance as pervasively as the Internet has changed communications .Well they are everywhere nowadays. The most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives. These instruments enhance the ability to differentiate risk and allocate it to those investors who are most able and willing to take it -- a process that has undoubtedly improved national productivity, growth and standards of living. Derivatives products provide certain important economic benefits such as risk management or redistribution of risk away from risk-averse investors towards those more willing and able to bear risk. Derivatives also help price discovery, i.e. the process of determining the price level for any asset based on supply and demand. All markets face various kinds of risks. This has induced the market par-ticipants to search for ways to manage risk. The derivatives are one ofthe categories of risk management tools. As this consciousness about risk management capacity of derivatives grew, the markets for derivatives de-veloped...
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...DERIVATIVES & RISK MANAGEMENT ASSIGNMENT – II By: ATTIKA RAJ, ROLL NO: MS10A009, MBA- 2012 BATCH, DOMS, IITM 2/21/2012 I. Case Analysis – Risk management Policy of Lufthansa Submitted in Assignment 1 II. Case Analysis: Commodity Market Derivatives Case Solutions: 1. Discuss the risk exposure of Amarnath hedge fund. Ans: The Amaranth hedge fund was exposed to following risks: a. Market risk: The risk that occurs from the volatility of investment returns b. Liquidity risk: It measures the degree of difficulty in exiting a given trading position c. Funding risk: It measures the extent to which they were able to meet margin calls on their natural gas position d. Capacity risk: The risk due to putting too much money into one particular strategy 2. What are the negatives to rolling a spread position? Ans: Negatives to rolling a spread position are: When rolling a spread position the investor expects the following months to which the contract was rolled over to be favourable and thus be able to unload its positions. But, if the market moves in a direction opposite to the one anticipated by the investor it can result in huge losses. Also, if the risk increases for a spread position with the increase in the leverage. In the case of Amaranth hedge fund, it had rolled its short positions prior to august into the next month, hoping that market conditions would change and enable it to unload its positions. There were now no more summer months into which it could roll these...
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...Forward Contract We start with an example of a simple forward contract. Arctic Fuels, the heating-oil distributor, plans to deliver one million gallons of heating oil to its retail customers next January. Arctic worries about high heating-oil prices next winter and wants to lock in the cost of buying its supply. Northern Refineries is in the opposite position. It will produce heating oil next winter, but doesn't know what the oil can be sold for. So the two firms strike a deal: Arctic Fuels agrees in September to buy one million gallons from Northern Refineries at $1.60 per gallon, to be paid on delivery in January. Northern agrees to sell and deliver one million gallons to Arctic in January at $1.60 per gallon. Arctic and Northern are now the two counterparties in a forward contract. The forward price is $1.60 per gallon. This price is fixed today, in September in our example, but payment and delivery occur later. (The price for immediate delivery is called the spot price Price of asset for immediate delivery (in contrast to forward or futures price).Arctic, which has agreed to buy in January, has the long position in the contract. Northern Refineries, which has agreed to sell in January, has the short position. Both companies have eliminated a business risk: Arctic has locked in its costs, and Northern has locked in its revenues for one million gallons of output. Do not confuse this forward contract with an option. Arctic does not have the option to buy. It has committed...
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...December 1, 2013 | $ 0.600 | 0.609 | December 31, 2013 | 0.610 | 0.612 | January 30, 2014 | 0.608 | 0.605 | March 31, 2014 | 0.602 | | Instructions Prepare all journal entries for Stark Industries for the following independent situations: a. The forward contract was to manage the foreign currency risk from the purchase of furniture for A$ 100,000 on December 1, 2013, with payment due on March 31, 2014. The forward contract is not designated as a hedge b. The forward contract was to hedge a firm commitment agreement made on December 1, 2013. To purchase furniture on January 31, with payment due on March 31, 2014. The derivatives is designated as a fair value hedge c. The forward contract was to hedge an anticipated purchase of furniture on January 30. The purchase took place on January 30. With payment due on March 31, 2014. The derivatives is designated as a cash flow hedge. The company uses the forward exchange rate to measure hedge effectiveness d. The forward contract was for speculative purposes only Problem 2 – Futures Peny One Inc. is a jewelry trading company. On November 1, 2013, Peny One Inc has 1,000,000 ounces of Gold carried at cost of $ 5,000,000 ($5 per ounce). Peny One Inc believes that the price of gold will decrease in the coming month due to bad economic recession. Therefore it decides to enter futures contract which has maturity date on March 31, 2014. In addition, Initial margin $ 0.05 per ounce is required to enter this contract. The following...
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...DERIVATIVES A derivative is a financial instrument - or more simply, an agreement between two people or two parties - that has a value determined by the price of something else (called the underlying). It is a financial contract with a value linked to the expected future price movements of the asset it is linked to - such as a share or a currency. There are many kinds of derivatives, with the most notable being swaps, futures, and options. However, since a derivative can be placed on any sort of security, the scope of all derivatives possible is nearly endless. Thus, the real definition of a derivative is an agreement between two parties that is contingent on a future outcome of the underlying. Some of the widely known underlying assets are: * Indexes (consumer price index (CPI), stock market index, weather conditions or inflation) * Bonds * Currencies * Interest rates * Exchange rates * Commodities * Stocks (equities) Categorization Derivatives are usually broadly categorized by the: * relationship between the underlying and the derivative (e.g., forward, option, swap) * type of underlying (e.g., equity derivatives, foreign exchange derivatives, interest rate derivatives, commodity derivatives or credit derivatives) * market in which they trade (e.g., exchange-traded or over-the-counter) * pay-off profile (Some derivatives have non-linear payoff diagrams due to embedded optionality) Another arbitrary distinction is between:...
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...Global Markets Fixed Range Swap Product Overview Outline A Fixed Range Swap is similar to a vanilla Interest Rate Swap, except that the fixed rate payable by the customer is discounted when LIBOR resets within a pre-agreed ‘range’. A LIBOR minimum/maximum ‘range’ is pre-agreed and when LIBOR periodically resets inside this range the customer pays a lower fixed rate while outside the range a higher fixed rate is payable. The Fixed Range Swap resets every rollover and is typically structured as a zero premium instrument. Applications This product is most suited to liability managers who require a cheaper fixed cost of funds. ● Where the market view is that floating interest rates are likely to remain stable or unchanged over the life of the transaction. ● Customer Cost of Funds % Benefits ● The lower fixed rate payable is cheaper than a vanilla Interest Rate Swap. ● Known maximum cost of funds. ● No immediate ‘cost of carry’ associated with fixed rate hedging in a positive yield curve environment. ● Can be structured as a ‘zero cost’ structure, i.e. no upfront premium. Risks Should LIBOR set below the lower strike, the higher fixed rate is payable for that rollover. ● In the event that LIBOR sets even marginally above the upper strike, the higher fixed rate is payable. ● Higher Fixed Rate Fixed Range Swap Interest Rate Swap Lower Fixed Rate Lower Strike Upper Strike LIBOR % Example A liability manager has GBP debt rolling on a 6 month LIBOR rate...
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...What are Derivatives? A) A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates, market indexes and “even some other derivative”. In short we can say that Derivatives is a “claim on a claim”, it enables the avoidance of unnecessary risk. Q) At what stage is Derivatives Market in Pakistan? A) In Pakistan, the derivatives market is in the nascent stage. It has been in this stage from 2004. Although in Pakistan trading in the derivatives market is done in different parts, but still it’s considered in the nascent stage, because there is no common awareness of this sort of market. In Pakistan trading in the derivatives market is done by. * Banks * DFIs * Mutual Funds * Non-Banking Financial Institutions * Islamic Banking Banks/DFIs may take exposure in future contracts to the extent of 10% of their equity on an aggregate basis. In this connection, the 10% exposure limit for future contracts will include both, positions taken in future buying and selling. Despite this regulatory support, Banks / DFIs participation is very low. Mutual Funds manage funds of the general public and they work under the supervision of their respective trustees. Mutual Funds mostly trade in equity derivatives to reap arbitrage...
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...ethical risks associated with derivatives. Derivatives are financial instruments with values that change relative to underlying variables, such as assets, events, or even prices. The ethical risk that derivatives pose is that they can be very risky for inexperienced investors. The basic of derivatives is that they offer a large reward but this can be a major risk if they are unaware of the investment that they are making at the time. Another ethical risk is that of the mangers and traders not taking into consideration the risk of their stakeholders and investors who has entrusted their investments. The last ethical risk I see is that they are being deceptive and not letting the investors know by not communicating with them and this is very unethical and a big risk because the investor is unaware. 2. Explain the difference between making a bad business decision associated with derivatives and engaging in unethical conduct using derivatives. When you make a bad business decision associated with derivatives you are basically not thinking logically and doing good business. You have the mindset but are not thinking and you are making a bad decision by engaging in derivatives in which you know that it will be bad for the company. Then in contrast when you engage in unethical conduct using derivatives you are aware of what you are doing and you engage in these acts because you are being unethical and trying to find the best way out by using derivatives. The main difference is...
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...Equity Derivative Strategies Equity Derivative Strategies Joanne M. Hill Vice President, Equity Derivatives Goldman, Sachs & Company Understanding the tax implications of equity derivatives and the application of these instruments for taxable U.S. clients is a challenge worth meeting. Equity derivatives can playa useful role in implementing tax-efficient strategies that maximize after-tax returns. The key is to understand the costs, benefits, and rules for applying each instrument or strategy and then to select the best instrument to accomplish the investor's objectives and minimize the taxes. istorically, u.s. trust departments that managed money for taxable investors were restricted in their use of derivative securities. Because of such obstacles (some of which are a matter of education more than anything else), derivatives are not the first tool that comes to mind for managing taxable investments, even though they offer advantages for many clients. Derivatives are often perceived as complex in themselves; the roles derivatives can play when taxes are involved add yet another layer of complexity. Equity derivatives, independent of any tax motivation, are used for reducing the risk of holding equities or as efficient substitutes for equities. In both contexts, derivatives have natural applications in tax-related strategies. This presentation discusses the general tax issues facing corporate money managers or high-networth individuals with respect to equity derivatives...
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...1 Lecture 1: Introduction to Derivatives 第一讲：衍生工具与衍生工具市场 Outline大纲 • Overview概览 • Types of Derivatives衍生工具的种类 • Derivatives Trading衍生工具交易 • The Notion of Arbitrage套利的概念 Lecture 1: Introduction 2 衍生工具概念 Derivatives is an instrument whose value depends on the values of other more basic underlying variables. Unlike shares, which are issued by companies and purchased by investors. Derivatives represents an agreement between a buyer and a seller. Thus, a derivatives contract is a zero-sum game.衍生工 具的价值依附于其他更基本的标的物(不一定原生品)，这与 股票不同，因为股票由公司发行，由投资者购买。衍生工 具是买者和卖者之间的一种合约，因此衍生合约是一种零 合博弈。 Primary security Equity Derivatives ISF: futures contract on individual shares; share options Index futures: futures contract on equity index; index options Interest rate futures; swaps Interest rate options; swaptions Bonds Lecture 1: Introduction 3 • Derivatives is not a terminology solely for rocket scientists. Real estate developers know options. They buy an option on a plot of land for a tiny fraction of its total value. That gives them the right to buy it at a fixed price by a fixed date. Insurance is also essentially an option of a different sort, an option that provides protection on your house and your car, your life. 衍生 工具不只是金融学家的术语。房地产开发商知道期权。他们以土地总 价值的很小比例来购买土地期权。这给与他们在特定日期以特定价格 购买土地的权力。保险也是一种能够为你的房子，车子和生活提供保 障的期权合约。 • Derivatives is becoming more important and popular in practice. „Derivative‟ appears in WSJ headlines only 2 times in 1990; in 1992, 8 times; in 1994...
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...WEATHER DERIVATIVE- A TOOL FOR WEATHER RISK HEDGING Most of the industries in the world are directly or indirectly affected by weather changes. Due to the adversity of global warming and the burning of fossil fuels, the weather has become quite unpredictable. Every now and then occurrence of drought, heavy and scanty rainfall is seen. As a result agriculture output becomes very irregular and this entails heavy losses not only to the farming community but also to the related industries. Although there is no way to control weather, there exists a new solution to the financial effect that weather can have on the incomes of economic agents of developed and emerging economies. There are number of instruments and tools available for management of weather risk. Weather risk management is a definitive guide to the rapidly expanding WRM market. It is the most dynamic sector of the financial arena and is drawing the interest of the companies that are seeking to protect against the financial impact of non catastrophic weather. So for hedging weather risk weather derivatives have been developed. DERIVATIVE TRADING Like any other derivatives weather derivatives are structured as Future, Option or swaps based on different weather indices. Usually most weather derivative transactions are done on over the SInternational Financial Future Option Exchange (LIFFE) offer standardized weather contracts. In India derivative instruments are traded both on OTC market and derivative exchanges...
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...Here is the definition at a reference site where you can look up other terms you need to define also. What Does Derivative Mean? A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. Investopedia explains Derivative Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region. Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros. English is always "simple" if you know the meaning of words. How can someone explain how an internal combustion engine works if you don't know the difference between...
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...CONTENTS CHAPTER 1: INTRODUCTION…………………………….. ................................................................ 4 1.1 1.2 1.3 1.4 DEFINITION OF D ERIVATIVES .....................................................................................................4 O RIGIN OF DERIVATIVES ............................................................................................................4 DERIVATIVES IN I NDIA ..............................................................................................................5 TWO IMPORTANT TERMS .............................................................................................................6 Spot Market ........................................................................................................................................................7 Index ......................................................................................................................................................................7 1.4.1 1.4.2 CHAPTER 2: DEFINITIO NS OF BASIC DERIVATIVES ............................................................... 8 2.1 FORWARDS...............................................................................................................................8 Settlement of forward contracts ............................................................................................................9 Default risk in forward contracts ...........................................................
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...Introduction The Global Derivatives Market how it is work a- Fundamentals and Market Characteristics 2.1 Basics of derivatives Derivatives are totally different from securities. They are financial instruments that are mainly used to protect against and manage risks, and very often also serve arbitrage or investment purposes, providing various advantages compared to securities. Derivatives come in many varieties and can be differentiated by how they are traded, the underlying they refer to, and the product type. Definition of derivatives A derivative is a contract between a buyer and a seller entered into today regarding a transaction to be fulfilled at a future point in time, for example, the transfer of a certain amount of US dollars at a specified USD-EUR exchange rate at a future date. Over the life of the contract, the value of the derivative fluctuates with the price of the so-called “underlying” of the contract – in our example, the USD-EUR exchange rate. The life of a derivative contract, that is, the time between entering into the contract and the ultimate fulfi llment or termination of the contract, can be very long – in some cases more than ten years. Given the possible price fluctuations of the underlying and thus of the derivative contract itself, risk management is of particular importance.1) Derivatives must be distinguished from securities, where transactions are fulfilled within a few days (Exhibit 1). Some securities have derivative-like characteristics...
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