18model - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
18model 10/6/2009 8:16 12/2/2002 Chapter 18. Spreadsheet Model for Derivatives A derivative is a security whose values are determined by the market price or interest rate of some other asset. Derivatives are a primary aspect of risk management, because they offer financial planners and risk managers an opportunity to hedge business risk. The term risk management can mean many things, but in business it involves identifying events that could have adverse financial consequences and taking actions to prevent and/or minimize the damage caused by such events. Effective risk management allows managers to control the costs of key inputs and protecting against changes in interest rates and exchange rates. Derivatives can include options (whose values depend upon the prices of some underlying stocks or other financial assets), interest rate futures, exchange rate futures, and swaps (whose values depend on interest rate and exchange rate levels), and commodity futures (whose values depend on commodity prices). OPTIONS An option is a contract which gives its holder the right to buy (or sell) an asset at a predetermined price within a specified period of time. Option contracts, though often quoted in terms of single shares, usually are contracts for a 100 shares. A call option describes a situation in which one investor may sell to someone the right to buy his/her shares of a stock over some interval of time. In this scenario, the writer of the call option (the party that surrenders the right to exercise) is said to hold a short position on the option. Meanwhile, the party that has purchased this right to buy is said to hold a long position on the option. The predetermined price that the stock may be purchased for is called the strike, or exercise, price. When an investor "writes" call options against stock held in his/her portfolio, this is called a "covered call". When the call options are written without the stock to back them up, they are called "naked calls". When the exercise price is below the current market price, the call option is said to be "in-the-money". Likewise, when the exercise price exceeds the current market price, the call option is said to be "out-of-the-money". For instance, if you believed that the price of stock was primed to rise, a call option would allow you to capture a profit off of the rise in price. A put option allows you to buy the right to sell a stock at a specified price within some future period. If you happened to believe that the price of a stock was ready to fall, a put option would allow you the opportunity to turn a profit out of that decline. In the cases of both call and put options, the profit or loss made on an options transaction is determined by the value of the underlying asset, the strike price of the option, and the price of the option. FOR A CALL, AT EXPIRATION
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 9

18model - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online