Week 2 - Chapter 2

Week 2 - Chapter 2 - Chapter2 AnIntroduction...

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1 FINA0301  Derivatives Faculty of Business and Economics  University of Hong Kong Dr. Tao Lin Chapter 2   An Introduction  to Forwards and Options
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2 Chapter Outline Basic derivatives contracts Forward contracts Call options Put options Types of positions Long  /  Short  position Graphical representation Payoff  /  Profit  diagrams
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3 Today Expiration date Forward Contracts Forward contract : a  binding  agreement  (obligation) to buy/sell an underlying asset in  the future, at a price set today
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4 Forward Contracts A forward contract specifies The  features and quantity  of the asset to be  delivered The  delivery logistics , such as time, date, and  place The  price  the buyer will pay at the time of  delivery Futures contracts  are the same as forwards in  principle except for some institutional and  pricing differences.
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5 Reading Price Quotes Index futures Expiration month The open price High of the day Low of the day Settlement price Daily change Open interest
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6 Payoff on a Forward Contract Payoff for a contract is its  value at expiration Payoff diagrams  show the gross value of a  position at expiration. Today: Spot price = $1,000,  6-month forward price  = $1,020 In six months at contract expiration:  Spot price = $1,050 Long  position payoff = $1,050 – $1,020 = $30   Short  position payoff = $1,020 – $1,050 = ($30)
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7 Payoff Diagram for Forwards Forward positions on the S&R 500 index
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8 Forwards vs. Spot Long forward = - Forward price +  1 * Spot price at expiration Short forward = Forward price + ( -1 )*Spot price at expiration  Spot price Payoff Spot price Payoff
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Forward vs. Outright Purchase Outright purchase:   Invest $1,000 in index and own the index.  Forward:   Invest zero, sign the contract Invest $1,020 at expiration and own the index.  Same  outcome: own the index at expiration. Why investing $1,000 now results in the same 
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This note was uploaded on 01/26/2010 for the course FINA 2802 taught by Professor Xia during the Fall '09 term at HKU.

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Week 2 - Chapter 2 - Chapter2 AnIntroduction...

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