DERIVATIVES

What are derivatives? Financial instruments whose price

depends on the movement of another price.

The value of the contract is derived from another asset.

↓the underlying asset:commodities, currencies, securities

Futures & forwards, options, swaps

COMMODITIES Wheat Coffee Palm oil Nickel Sugar Maize Milk Bauxite Iron ore Wool Grain Rubber

Wine Copper Beef Tea Zinc Gold Lead Oil Phosphates Tin Timber Silver

Commodities can be traded...

...for immediate delivery at their current prices on spot markets

... for future deliveries at prices fixed at the time of the deal on futures markets

Futures

Study the example of a silversmith and fill in the missing words (next slide)

http://www.investopedia.com/university/futures/futures3.asp

Futures: The Case of a Silversmithhttp://www.investopedia.com/university/futures/futures3.asp

A silversmith must secure a certain amount of silver in six months time for earrings and bracelets that have already been advertised in an upcoming catalog with specific prices.

But what if the price of silver ………….over the next six months? Because the prices of the earrings and bracelets are already ………., the extra cost of the silver can't be passed on to the ……….. buyer, meaning it would be passed on to the silversmith.

The silversmith needs to ………….., or minimize his ………….. against a possible price ………….. in silver. How?

Futures: The Case of a Silversmith http://www.investopedia.com/university/futures/futures3.asp

The silversmith would enter the ……………….. market and purchase a silver contract for settlement in six months time (let's say June) ……………a price of $5 per ounce.

At the end of the six months, the price of silver in the cash market is actually $6 per ounce, so the silversmith benefits from the futures …………… and escapes the higher price.

Had the price of silver …………….in the cash market, the silversmith would, in the end, have been better off without the futures contract.

At the same time, however, because the silver market is very ………………., the silver maker was still sheltering himself from risk by entering into the …………………contract.

OptionsStudy the two theoretical situations illustrating the

buying of an option in an everyday situation:http://www.investopedia.com/university/options/

option.aspAnswer the questions: What value is the derived

value in the previous example? What options did the buyer of the option have? What was the underlying asset involved? What can affect the price of an option in this case? Who takes most risk? Is this option a call option or a put option?

Can you find synonyms and opposites in MK:p.92?floating rate put option hedging

agreed-upon price option to sell

pre-determined price swap

call option speculation exchange

option to buy fixed rate

pre-arranged price strike price

Spread – betting (MK: p.93)

1. Explain the reason for calling such transactions “spread-betting”?

2. Two reasons for spread-betting?3. Risky only?