chapter 2 - Chapter 2 An Introduction to Forwards and...

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FINA0301 Derivatives Faculty of Business and Economics University of Hong Kong Dr. Tao Lin Chapter 2 An Introduction to Forwards and Options 1
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Chapter Outline Basic derivatives contracts Forward contracts Call options Put options Types of positions Long / Short position Graphical representation Payoff / Profit diagrams 2
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Forward Contracts Forward contract : a binding agreement (obligation) to buy/sell an underlying asset in the future, at a price set today 3 Today Expiration date
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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. 4
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Reading Price Quotes Index futures 5 Expiration month The open price High of the day Low of the day Settlement price Daily change Open interest
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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) 6
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Payoff Diagram for Forwards 7
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Forwards vs. Spot Long forward = - Forward price + 1 * Spot price at expiration Short forward = Forward price + ( -1 )*Spot price at expiration 8 Spot price Payoff Spot price Payoff
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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
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This note was uploaded on 11/07/2010 for the course FINANCE fina0301 taught by Professor Lintao during the Spring '10 term at HKU.

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chapter 2 - Chapter 2 An Introduction to Forwards and...

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