Lecture 10 Chpt 9 D2L 2011

Lecture 10 Chpt 9 D2L 2011 - Fin 320 Chapter 9: Risk...

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Fin 320 Chapter 9: Risk Management Lecture 10
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Derivatives: 1. Defining Derivatives What is a derivative? How are derivatives used? 1. Types of Derivatives Options: Calls and Puts Swaps
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Derivatives: An Example In the winter of 1998, Bombardier offered a $1000 rebate to buyers of snowmobiles if there wasn’t enough snowfall. They bought “weather derivatives” to hedge this risk, transferring it to someone else. Without the ability to transfer the risk, Bombardier may not have been able to afford to offer the rebate and sold fewer snowmobiles.
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Derivatives: Definition Derivative is a financial instrument whose value is derived from the value of an underlying asset Examples of assets include stocks, bonds, wheat, snowfall, and stock market indexes like S&P 500.
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Derivatives: General Properties The purpose of a derivative is to allow risk to be transferred. Derivatives are all zero sum – when one side gains, the other side loses Derivatives are different from outright purchases because: Derivatives provide an easy way for investors to profit form price declines.
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Forward Contracts and Futures Contracts A forward contract is an agreement between a buyer and a seller to exchange a commodity or financial instrument for cash on a prearranged future date for a specified price. No money changes hands when the agreement is made.
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Forward Contracts and Futures Contracts Futures contracts are forward contracts that are standardized and sold through organized exchanges. The contract specifies that the seller - who has the short position - will deliver some quantity of a commodity or financial instrument to the buyer - who has the long position - on a specific date, called the settlement or delivery date, for a predetermined price
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9-8 Forward and Futures No payments are initially made when the contract is agreed to. The seller/short position benefits form declines in the price of the underlying asset. The buyer/long position benefits from increases in the price of the underlying asset.
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9-9 Forward and Futures The two parties to a futures contract each make an agreement with a clearing corporation. The clearing corporation operates like a large insurance company and is the counter party to both sides of the transaction. They guarantee that the parties will meet their obligations. This lowers the risk buyer and sellers face. The clearing corporation has the ability to monitor traders and the incentive to limit their risk taking.
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Margin Accounts and Marking to Market The clearing corporation requires both parties to place a deposit with the corporation. This is called posting
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This document was uploaded on 10/26/2011 for the course FIN 320 at DePaul.

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Lecture 10 Chpt 9 D2L 2011 - Fin 320 Chapter 9: Risk...

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