derivatives - 2/14/11 Finance 363: Lecture 1 11 Derivative...

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Unformatted text preview: 2/14/11 Finance 363: Lecture 1 11 Derivative Securities Readings: Online Chapter on Derivatives 2/14/11 Finance 363: Lecture 1 22 What is a Derivative? Characteristics of Derivatives: Financial security whose value is a function of price of some underlying asset , but which does not represent ownership in that asset. Derivative's are not "issued" by firms, instead they are contracts between secondary parties . Essentially a bet on the future value of the underlying asset. 2/14/11 Finance 363: Lecture 1 33 Pervasive Use of Derivatives Nov 2, 2009 - International Swaps and Derivatives Association survey of derivatives use by the worlds 500 largest companies: 94% of these companies use derivative instruments to manage and hedge their risks more effectively. 2 4 6 8 10 12 2/14/11 Finance 363: Lecture 1 2 4 6 8 10 12 Notional Amount ($ Trillions) The Market is Huge: Swaps 2/14/11 Finance 363: Lecture 1 55 Common Derivatives Four most common derivatives Forward contracts. Futures contracts. Options. Swaps. Typical underlying assets: Agricultural commodities. Raw materials. Primary financial securities: bonds, stock, etc. Oddball items . 2/14/11 Finance 363: Lecture 1 66 Forward Contract Example: Assume two "players" are interested in arranging a forward contract for winter wheat. Players agree on forward price, date, quantity, etc. Two-sided promise: Long position agrees to buy the underlying asset at the maturity date (T) Short position agrees to sell (deliver) the underlying asset at the maturity date (T). Both sides are legally obligated by the terms of the forward contract. 2/14/11 Finance 363: Lecture 1 77 Uses of Forward Contracts Consider a wildcat oil drilling firm: Business description. Why/how might they use a forward? Who might be a potential counter-party? Consider a Japanese auto company like Toyota: Business description. Why/how might they use a forward? Who might be a potential counter-party? 2/14/11 Finance 363: Lecture 1 88 Characteristics of Forward Contracts Custom tailored Traded over-the-counter, not on exchanges Default (counter-party) risk is a concern v Buyers/Sellers are usually large institutions Contracts are often illiquid 2/14/11...
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This note was uploaded on 02/14/2011 for the course FINA 363 taught by Professor Masoudie during the Fall '10 term at South Carolina.

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derivatives - 2/14/11 Finance 363: Lecture 1 11 Derivative...

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