dr1_lecture - Outline of derivative lectures FNCE102 R....

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FNCE102 R. Loh: Derivatives 1 Week 12 Futures and Options 2/36 Roger Loh Outline of derivative lectures ± Part 1: Options and futures { Call and put options { Determinant of option value { Option payoff diagrams { Hedging with options { Futures versus forwards { Pricing contracts { Margin futures requirements of futures ± Part 2: Interest rate derivatives { Forward rate agreements (FRAs) { Interest rate swaps 3/36 Roger Loh Derivatives ± Securities whose value is derived from the value of some underlying asset or financial instrument ± Underlying asset can be a stock, T-bill/bond, foreign currency, commodity or even another derivative security ± Derivative security prices are related to factors affecting prices in the spot market for the underlying asset ± Types of derivatives { Forwards { Futures { Options { Swaps 4/36 Roger Loh Forward Contracts ± Agreement to buy or sell a specified quantity of an asset at a specified price, with the delivery at a specified time and place ± Party that agrees to buy has a long position ± Party that agrees to sell has a short position Features of Forwards 1. Settled with cash and delivery of physicals at maturity 2. Contract size negotiable 3. Transacted OTC, not on an exchange
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5/36 Roger Loh Futures ± Agreement to buy or sell a specified quantity of an asset at a specified price, with the delivery at a specified time and place But futures are different from forwards in that… 1. Delivery may not take place. Instead position is cash settled at maturity or reversed before maturity. 2. Position is marked to market every trading day 3. Contract specifications are standardized 4. Transacted on an exchange with guaranteed settlement 6/36 Roger Loh Purpose of trading Futures ± To Speculate { Take a position with the goal of profiting from expected changes in the contract’s price { No position in underlying asset ± To Hedge { Minimize or manage risks { Have position in spot market with the goal to offset risk 7/36 Roger Loh Marked to market ± The futures position will be marked to market ± An initial margin is required from the investor ± Any gains or losses on the contract value will be reflected on the margin account ± When the margin account drops below the maintenance margin, a margin call will be triggered ± The investor have to top up an amount which brings the margin account back to the initial margin 8/36 Roger Loh Payoff From Futures Position $45 0 LONG Position $45 0 SHORT Position Futures Price at settlement date Profit ($) Profit ($) Futures Price at settlement date An investor has a long (short) position on crude oil futures at $45. Settlement in 1 month’s time.
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9/36 Roger Loh Valuation of Financial Futures ± The futures price is always linked to the spot price of the underlying asset. However, the impact of opportunity costs or benefits of owning the futures instead of the asset could cause the futures price to be different from the spot price ± Example of such costs and benefits of futures
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This note was uploaded on 06/06/2009 for the course SOB FNCE102 taught by Professor Rogerloh during the Spring '09 term at Singapore Management.

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dr1_lecture - Outline of derivative lectures FNCE102 R....

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