Derivatives

Derivatives

Derivatives& Financial Implications

Introduction to Derivatives

Derivatives are financial contracts whose value is determined by fluctuations in the underlying asset can be exchange rate or interest rate. Derivative contract specifies the rights and obligations of the parties with respect to common claims, which are calculated based on the value of the underlying instrument at a predetermined future date or at regular intervals.

Derivatives are belonged from the family of financial instruments having monetary values that define right and obligation between two parties. It based on another property called the underlying asset. The property can be listed directly (such as a stock, commodity or currency), or a measure of the assets an index of any (which can trade it through an ETF) to the index of something virtual brand such as Market Index(Roe, 2011).

Characteristics

All derived from the following characteristics:

They define an agreement between the seller and the buyer relating derived some base index (quantity, price)

They traded in continuous trading

They have monetary value

They have expiration date

Sorting derived types can be made according to various attributes:

Type the derivative (futures, options, swap contract)

Index type base (currency, stock, index, commodity, etc.)

Market in which they are traded ( NYSE , First Market Maker)

How to order expiry of derivative liability (charge actual transfer of goods)

Analyzing the Derivative Market and its Specifications

While analyzing the Derivate Market we need to focus on the following:

Options

Forward Contracts

Future Contracts

Swap Agreements

Credit Derivatives

Option

An option is a right but not an obligation, at a time to buy or sell securities, goods or other benefits to a pre-agreed price. There is a distinction between American and European options. An American option can be exercised at any time up the due date, while a European option can only be exercised on the maturity date. Financial options traded in most European and American stock exchanges are American(Siems, 1994).

Option's biggest advantage is its flexibility. Using options can investors position the market regardless of market expectations and risk profile. He can make money on that market is rising, falling or standing still. He may also use options for lowering the risk of its stock portfolio. The other big advantage is the low investment cost. The investor can with a significantly lower amount compared to stocks, control a larger percentage shares in that he owner a right to buy these. These results in a small change in the underlying object will be able to provide a very high return. This opens the opportunity to earn lots of money with low investment. However, the risk increases considerably. If the market expectation proves to be wrong, the option expires worthless and you lose all investment.

Forward Contracts.

Forward contracts are designed to facilitate and streamline trade. It has therefore standardized conditions in terms of nature and scope of the underlying object, contract size, maturity and futures prices. The parties do not pay any premium amount at the inception of the contract, but must deposit an amount (margin) to safety for future liabilities(Fujii, 2013).

Swaps

An interest rate swap agreement is that contracting parties enter into a mutually ...