Ch1.0.pptx - Chapter 1 Introduction 1 What is a Derivative A derivative is an instrument whose value is derived from the value of another underlying

Ch1.0.pptx - Chapter 1 Introduction 1 What is a Derivative...

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Chapter 1 Introduction 1
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What is a Derivative ? A derivative is an instrument whose value is derived from the value of another underlying asset Examples: futures, forwards, swaps, options, exotics... 2
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Why Derivatives Are Important Derivatives play a key role in modifying risks in the economy The derivatives market is huge and versatile . The underlying assets include stocks, currencies, interest rates, commodities, debt instruments, electricity, insurance payouts, the weather, etc. 3
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1.1 How Derivatives Are Traded On exchanges such as the Chicago Board Options Exchange (CBOE) In the over-the-counter (OTC) market where traders working for banks, fund managers and corporate treasurers contact each other directly 4
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1.2 The OTC Market Prior to 2008 Largely unregulated: Participants in the OTC market contact each other directly or by a broker (banks act as market makers) Once an OTC trade has been agreed, the two parties can either present it to a central counterparty ( CCP ) or clear the trade bilaterally . Master agreements usually defined how transactions between two parties would be handled 5
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The Lehman Bankruptcy (Business Snapshot 1.1) Lehman’s filed for bankruptcy on September 15, 2008. This remains the largest bankruptcy in US history Lehman was an active participant in the OTC derivatives markets, holding on large positions in subprime and other lower-rated mortgage tranches when securitizing the underlying mortgages 6
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Since 2008… OTC market has become regulated. Objectives: Reduce systemic risk (see Business Snapshot 1.2) Increase transparency Standardized OTC products must be traded on swap execution facilities ( SEFs ) which are similar to exchanges Central counterparties ( CCPs ) must be used for standardized transactions between dealers All standardized trades must be reported to a central registry 7
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  • Spring '15
  • Mohammad M. Mousavi

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