673_02 - INTRODUCTION TO DERIVATIVE SECURITIES NBA673...

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INTRODUCTION TO DERIVATIVE SECURITIES NBA673 – Lecture 1 January 24, 2006
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Introduction A derivative security is a financial contract whose value is derived from an underlying asset. Examples: A stock option’s value depends upon the value of a stock on which the option is written. A gold futures contract’s value depends on gold’s spot price (price for buying “now”)
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Derivatives: Examples and Uses Futures and options are standardized. They trade in organized exchanges. Forward and swaps are customized. They trade in OTC inter-bank market. These derivatives are used for hedging (risk-reduction) or speculation (high risk trading).
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Forward Contract A forward is an agreement between a buyer (“long”) and a seller (“short”) to trade a specified quantity of an asset at a specified price (forward/delivery price) at a specified time (maturity/delivery date) and place. Example: Buy 25oz gold at $300/oz in 3 months.
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Forwards- Formalization Time t (start) Time T (delivery) | | Forward price K is set Long gets S ( T )- K No cash changes hand Short gets –[ S ( T )- K ] Buyer = Long Seller = Short S ( T ) = Spot at time T K = Delivery Price
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Value of Long Forward on Gold at Delivery Value S ( T ), Spot at Delivery 300 0 -300 Delivery price: $300/oz
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Futures Contract Forwards and futures are similar: they can be stated as “contract now, transact later.” But unlike forwards, futures are standardized regulated exchange-traded settled through a clearing house post daily gains and losses (daily settlement) .
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Example: Gold Futures Contract Gold futures trade in CBOT 100 troy oz. per contract Tick size 10 cents, daily price limit $50 per oz. Last trade on 4 th to last business day of delivery month Standardized trading hours, contract months, deliverable grades, and delivery place/s.
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Delivery Process of Futures Short (seller) can initiate delivery process: Day 1 ( Position Day ) Short’s broker notifies
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This note was uploaded on 09/28/2008 for the course NBA 6730 taught by Professor Janosi,tibor during the Spring '06 term at Cornell University (Engineering School).

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673_02 - INTRODUCTION TO DERIVATIVE SECURITIES NBA673...

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