winter2010_notes_part1

winter2010_notes_part1 - Derivatives Fin 823 823 Mon/Wed...

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Derivatives in 823 Fin 823 Mon/Wed 3:30pm-5:18pm erlach 75 Gerlach 275 Professor Kewei Hou 1-1
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What Is a Derivative? efinition Definition An agreement between two parties which has a value determined by the price of something else Types Options, futures and swaps Uses Risk management Speculation Reduce transaction costs 1-2 Regulatory arbitrage
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Three Different Perspectives conomic nd users termediaries Economic Observers Regulators End users Corporations Investment Intermediaries Market-makers Traders Observers Researchers managers Investors End user End user Intermediary 1-3
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Financial Engineering he construction of a financial product from The construction of a financial product from other products ew securities can be designed by using New securities can be designed by using existing securities inancial engineering principles Financial engineering principles Facilitate hedging of existing positions nable understanding of complex positions Enable understanding of complex positions Allow for creation of customized products ender regulation less effective 1-4 Render regulation less effective
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The Role of Financial Markets surance companies and individual Insurance companies and individual communities/families have traditionally helped each other to share risks Markets make risk-sharing more efficient Diversifiable risks vanish Non-diversifiable risks are reallocated Recent example: earthquake bonds by alt Disney in Japan 1-5 Walt Disney in Japan
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Exchange Traded Contracts ontracts proliferated in the last three decades Contracts proliferated in the last three decades hat were the drivers behind this proliferation? 1-6 What were the drivers behind this proliferation?
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Increased Volatility… il prices: Oil prices: 1947–2004 $/£ rate: 1947–2004 1-7
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…Led to New and Big Markets xchange- aded derivatives Exchange traded derivatives ver e ounter traded derivatives: even more! 1-8 Over-the-counter traded derivatives: even more!
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Basic Transactions uying and selling a financial asset Buying and selling a financial asset Brokers: commissions Market-makers: bid-ask (offer) spread Example: Buy and sell 100 shares of XYZ XYZ: bid = $49.75, offer = $50, commission = $15 Buy: (100 x $50) + $15 = $5,015 Sell: (100 x $49.75) $15 = $4,960 Transaction cost: $5015 $4,960 = $55 1-9
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Short-Selling When price of an asset is expected to fall First: borrow and sell an asset (get $$) Then: buy back and return the asset (pay $) If price fell in the mean time: Profit $ = $$ – $ The lender must be compensated for dividends received (lease-rate) xample: short ell IBM stock for 90 days Example: short-sell IBM stock for 90 days 1-10
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Short-Selling (cont’d) Why short-sell?
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winter2010_notes_part1 - Derivatives Fin 823 823 Mon/Wed...

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