requires cash deposit margin bond or performance bond from participants

How do dealers hedge their risk?  Key Characteristics : • Flexibility & Customization • Privacy • Lower Liquidity • Higher Credit Risk

4 – Types of Derivatives  Forward commitments  Obligation a. Forward contracts b. Futures c. Swaps  Contingent claims  Contingent on an event a. Options b. Credit derivatives c. Asset-backed securities  Hybrids a. E.g. callable bonds, convertible bonds etc.

 Forward Commitments a. Forward contracts  Key Terminologies / Concepts : • Spot Price • Forward Price • Pay-off / Value of Contract

 Settlement of Forward Contracts :

 Pay-off from Forward Contracts:

 Marking to Market

 The account is referred to as Margin Account : • Initial margin? • Maintenance margin? • Margin call?

 Provisions Limiting Price Changes :  Definition of Open Interest :

 Futures Price Eventually Converges to Spot Price :

 Plain Vanilla Swap :

 Converting a floating-rate loan to a fixed-rate loan:

 Swaps vs. Actual Loans : • Other Differences :  Lower credit risk than loan because notional principal is not exchanged  There are also interest rate swaps in which one party pays based on one reference rate while the other party uses another reference rate