DERIVATIVES

Derivatives



Derivatives

Answer 1)

No, I disagree with this statement as without derivative instrument hedging interest rate risk cannot be possible. Over-the-counter financial market is known as forward market in order to contracts for future delivery.

A derivative instrument or a financial derivative is a financial product whose value is based on the price of another asset. The dependent assets take the name of the underlying asset, such as the future value of gold is based on the price of gold. The underlying used can be very different, shares, stock indices, fixed income securities, interest rates or even raw materials. Whereas, hedging is concern it is opening transactions in one market to compensate for the impact of commodity price risks equal but opposite position in another market. Usually hedging is carried out to the insurance risks of price changes by entering into transactions in futures markets. In addition to transactions in futures, hedging transactions may be considered, and operations with other futures instruments: forward contracts and options. Sale of an option under the rules of IFRS cannot be recognized as hedges (Belghitar Y., Clark E., & Judge A. 2008, pp. 43).

Hedging is buying (hedge buyer, a long hedge) is associated with the acquisition of futures, which provides insurance against the buyer a possible rise in prices in the future.

Hedging against risk is eliminated the uncertainty of an undesirable trend in the exchange rate so as to protect themselves from any possible loss of value over time, when the transaction must take place. Practical example of a importer:

Suppose an importer buys goods from U.S. exporter to a value of 2000 USD to be paid within a maximum of 1 year.

The importer, to hedge against a rise in the dollar against the Euro in 1 year, he wants to have a fixed rate today to buy a 1 year the 2000USD (forward). To do this, consult your banker.

That the banker offers the importer is to buy term (one year) the 2000USD with the following course: 1USD = 0.676 EUR, ie at the date of payment, importer buys 2000USD for this course said term, and whatever the spot price that would apply at that date (a year).

We are interested in this case, to disclose the bank's procedures for setting such a futures exchange. To determine this course, we need the following information: The spot price 2000USD to buy, the rate for borrowing in Euro and rates to place the dollars.

The information available on the financial market is, for example:

The way to buy 2000 USD today is 1USD = 0.68 EUR

The rate to borrow EUR in the market is 1.5%

The rate of investment of USD in the U.S. market is 2%

The bank, to determine the forward price, performs the following three:

She buys 2000USD today: 2000USD = 2000.0,68 EUR = 1360EUR

Before buying 2000USD, he borrowed enough to buy them. Ie, it borrows 1360EUR

The bank did not need 2000USD that in a year, so there's room for a ...