Introduction to Capital Markets.ppt

8/10/2019 Introduction to Capital Markets.ppt

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Copyright 2007 Accenture All Rights Reserved. Accenture, its logo, and High Performance Delivered are trademarks of Accenture.

Introduction to Capital Markets


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2Copyright 2007 Accenture All Rights Reserved. Accenture, its logo, and High Performance Delivered are trademarks of Accenture.

What makes a market?

Agents who need money, agents who are willing to investmoney and intermediaries who bring these peopletogether

How can money be raised? There are numerous differentways of performing this particular trick. Having raised orinvested money, how can agents manage the subsequentrisk?

PEOPLE

PRODUCTS

PLACES

How are deals executed? Are assets freely transferable? Isthere a physical market place?


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Why do Markets matter?Below are some key operations the financial markets:

Price discovery andAsset Valuation

Markets bring together buyers andsellers and provides Price Discovery forindividual assets. This in turn allowsoverall valuation of asset portfolios.

CapitalOpportunities

Equities, debt and other financialinstruments enable firms andgovernment to raise money for buildingnew factories, invest in public work, etc.

Short Termfinancing

Companies require working capital;money to pay now for inventory, wages,and so on. If they are conductingbusiness in overseas market , theyrequire the ability to exchange differentcurrencies.

InvestmentOpportunities

Agents who dont need money now, caninvest their surplus cash to generate areturn and to build up a future assetportfolio

Financial RiskManagement

Agents are often exposed to risk in theform of market movements. Marketsprovide protection against changes inasset values. Example- Derivativesmarket


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Components of a Market

Agents raising money such as corporate looking for future capital to expand orgovernment utilizing short term financial markets for working capital.

Agents investing money such as mutual fund purchasing equities.

Market intermediaries who bring borrowers and investors together such as anInvestment Bank.

Regulators who overseas the integrity of Financial Markets.

2) Products:

Securities or contractual agreements

Debt or Equity

Money Market/Capital Market Instruments

Exchange Traded or OTC

Some examples of financial products being Equities, bonds, FX, commodities, Derivatives, etc

1) Participants:


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Components of Market continued.

Stock Exchange:

A stock exchange, share market or bourse is a corporation or mutualorganization which provides facilities for stock brokers and traders, to tradecompany stocks and other securities

Over-the-counter (OTC):

OTC trading is to trade financial instruments such as stocks, bonds,commodities or derivatives directly between two parties

3) Market Places:

Organized market with specific anddetailed trading rules

Exchange defines the rules of the gameand enforces them

Highly transparent Quotes and prices are available very

rapidly by numerous services Less credit risk

Deals are negotiated in opaquemarket

Dealer market where brokers anddealers make two-way markets

Sometimes brokered Often lacks transparency, esp. for

customized and new transaction prices Plain vanilla products are more

standardized

More credit risk

Stock Exchange OTC


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7/467Copyright 2007 Accenture All Rights Reserved. Accenture, its logo, and High Performance Delivered are trademarks of Accenture.

Introduction to Capital Markets

The Capital Markets consists of a primary market, a secondary market and an infrastructure thatfacilitates each .

Investment banks facilitate creation of capital assets bymatching those who need to secure capital (issuers) with

providers of funding (investors)

Primary Market

Issuers Investors

Global Intermediaries

Investors Investors

Secondary MarketFinancial institutions sell and trade securities tomaximize performance of a portfolio of assets

consistent with an investors investment objectives

Shared industry services facilitate the trading,movement, settlement and safekeeping of securities

Market Infrastructure



Primary Market

Issuers

Require capital and arewilling to offer securities toothers in order to obtainthese funds. Securitiescould be stocks, bonds,options, warrants, etc.

Invest capital for future returns.Provide corporate finance services andoriginate and trade equity and debt.Serve as an intermediary betweenissuers and investors, mainly byunderwriting. Institutions

Insurance companies Deutsche Bank Goldman Sachs Merrill Lynch Morgan Stanley Nomura UBS

Corporations

High net worth individuals Government bodies

Government bodies Small and medium

enterprises

Investment Banks Investors

Primary market comprises of Issuers, Investment Banks and Investors

Primary Market is usually synonymous with IPO.

Initial Public Offering (IPO) IPO refers to first sale of stock by private company to the public so metimes called going public. IPO first came into everyday parlance during late 1990s



Type Description Examples

FullServiceBrokers

In addition to executing trades for itsclients, also provides them withresearch, planning and advice services.Full Service Brokers charge higher feesfor these additional services and valuethe personal relationships with clients.

AG EdwardsDeutsche BankMerrill LynchShinko SecuritiesUBS

Provide market access & execution services

Brokers find trading partners for customers andnegotiate transaction prices acceptable to bothparties of the trade for a fee.

Dealers are firms or individuals who act as theprincipal in a securities transaction.

DiscountBrokers

Provide low cost market access to

primarily self-directed clients.Historically focused bare-bonesfeatures (via online & phone channels),but increasingly introducing advancedresearch and planning tools.

Ameritrade

Charles SchwabCortal ConsorsE*Trade Financial

FundManagers

Managed pooled investments, such asmutual funds and unit investmenttrusts. Customers will then buy and sellunits of that fund.

Deutsche BankFidelity

Merrill LynchUBSVanguard

Develop investment strategies and makeinvestment decisions

Asset Management Services typically referredto in the context of Institutional Investors.

InvestmentManagers

Develops a strategy for a portfolio for aspecific individual or institution. Makesinvestment decisions on behalf of theirclients.

Allianz DresdnerMerrill LynchSanford BernsteinVarious Private Banksand Independents

Secondary Market

Trade equity and/ordebt for retail and/orinstitutional accounts

Broker / Dealer

Manage retail andinstitutional assets for

clients for a fee

Asset / Investment

Manager




Provide a vehicle for the trading of securities by members for their own accountsand their customers accounts. Can be physical locations, over -the-counter (OTC)and electronic communication networks (ECNs).

Facilitate the validation, delivery and settlement of securities transactions.Affiliated with exchanges.

Store physical securities. Trades involving the securities are made and accountsat the depository are debited and credited, but the physical securities are notmoved.

CME Deutsche Borse

Clearstream

Crest

NYSE Euronext LSE

NASDAQ TSE

MarketAxess

Provide back-office services (clearing and settlement, recordkeeping andsafekeeping) for other institutions. Ancillary services include foreign exchangeexecution, cash management, securities lending, accounting, performancemeasurement and customized reporting.

Bank of New York BNP Paribas

JPMorgan Chase HSBC

Societe Generale State Street

Exchange/ECN

Clearing House/Clearer Crest DTCC - NSCC Euroclear Pershing

DTCC - DTC Euroclear

Depository

Custodian



How they are integrated

Trade equity and/or debtfor retail and/or

institutional accounts.

Manage retail andinstitutional assets for

clients for a fee.

Invest capital for futurereturns.

Provide corporatefinance services andoriginate and trade

equity and debt.

Require capital and arewilling to offer securities

to others in order toobtain these funds.

Investors (Lenders)

Investment Bank

Issuers (Borrowers)

Asset/Investment Manager

Broker/Dealer

Secondary Market

(Sales and Trading)

Primary Market

(Investment Banking)


(Execution/Settlement/Safekeeping)

BuySell Market Infrastructure

Provide vehicle for the tradingof securities by members fortheir own accounts and their

customers accounts.

Exchange

Holds and safeguards anindividual, or institutions

assets.

Custodian

Facilitate the validation, deliveryand settlement of securities

transactions.

Clearing Agency

Store physical securities.

Depository



Type of Techniques

Hedge : Hedging is a strategy designed to minimize exposure to an unwantedbusiness risk, while still allowing the business to profit from an investment activity.Hence, hedgers are mainly interested in protecting themselves against adverse pricechanges- want to avoid risk

Speculate : speculation, involves the buying, holding, selling, and short-selling ofstocks, bonds, commodities, currencies, collectibles, real estate, derivatives, or anyvaluable financial instrument to profit from fluctuations in its price as opposed tobuying it for use

Hence, Speculators hope to make money in the markets by betting on thedirection of prices accept risk

Arbitrage: arbitrage is the practice of taking advantage of a price differential betweentwo or more markets: a combination of matching deals are struck that capitalize uponthe imbalance, the profit being the difference between the market prices.

Hence, arbitrageurs usually lock into risk-less profit by simultaneously enteringinto transactions in two or more markets



Regulatory and Compliance Laws ImpactingCapital Markets

MiFID (The Markets in Financial Instruments Directive): Provides one passport for investment firmsand provision of investment services across the European Union for all impacted products on thebasis of a single authorization (Transparency is a major theme, particularly in regards to investorprotection.)

Regulation NMS: Intends to improve and modernize markets through greater connectivity as theystop operating in the worlds of both manual and electronic trading and forces greater technologicalinnovation

Basel II Accord: Imposes new standards for risk measurement, capital adequacy and transparency,requiring greater consistency and integrity in a firm's information systems

U.S.A. Patriot Act, Know Your Customer (KYC) and 3rd Money Laundering Directive: Expandsexisting regulations against fraud and money laundering, requiring stronger verification andtracking processes

U.K. Money Laundering: Requires due diligence procedures for institutions issuing credit orallowing customers to open accounts

Sarbanes-Oxley: Prescribes new controls to ensure the honesty and transparency of companyfinancial statements and business controls, requiring prompt and accurate processing of accounting

International Accounting Standards (IAS): Requires new levels of disclosure to prevent off-balancesheet activities and other forms of fraudulent accounting



Introduction to Equities



Introduction- Investing

What is Investment?

The money you earn is partly spent and the rest saved for meeting future expenses. Instead of keepingthe savings idle you may like to use savings in order to get return on it in the future. This is calledInvestment.

Why should one invest?

One needs to invest to: earn return on your idle resources generate a specified sum of money for a specific goal in life make a provision for an uncertain future

What are various options available for investment?

Physical assets like real estate, gold/jewellery, commodities etc. Financial assets such as fixed deposits with banks, small saving instruments with post offices,

insurance/provident/pension fund etc. or securities market related instruments like shares, bonds,debentures etc.



Introduction - Equities

What is equity??

- Equity generally means the ownership interest in a corporation.

Why Equity??

For Corporate:- Equities finance the purchase of long-term assets, such as machines and factories.

For Investors:- Have a claim to the future profits generated by the purchased assets.- Equities or shares can be easily traded (sold) to other investors in the stock market and are thus

said to be liquid, or readily converted to cash.


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Characteristics

The characteristics of the stock are:

Limited Liability Which means that as an owner of a stock, you are not personally liable if the company is not able to pay

its debts A type of liability that does not exceed the initial amount a person invested into a partnership.Limited liability protects a partner's personal assets from being liquidated should the company becomeinsolvent.

Voting Privileges The right of a stockholder to vote on matters of corporate policy as well as on who is to compose the

board of directors.

Lower priority of claims in bankruptcy In case of bankruptcy, creditors are paid first, the shareholders get whatever is left with preferred

shareholders having preference over common shareholders .

Dividends A distribution of a portion of a company's earnings, decided by the board of directors, to a class of its

shareholders . Dividends may be in the form of cash, stock or property.


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Types - Equities

Common Stock :

Common stock acts as a unit of ownership in the companys profits and usually carries votingrights that can be exercised in corporate decisions.

Types of Common Stock are: Utility Stocks Represent Ownership in Public Utility Companies Blue Chips- Stocks of largest Corporations Established Growth- Stocks of companies that are showing solid profitability Penny Stocks- Stocks of companies that have very little growth.

Preferred Stock:

Differs from common stock in that it typically does not carry voting rights but is legally entitledto receive a certain level of dividend payments before any dividends can be issued to othershareholders


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Equity linked securities

Right

A rights issue is an issue of new shares for cash to existing shareholders in proportion to their existingholdings. The price at which the new shares are issued is generally much less than the prevailingmarket price for the shares .

Example- Company XYZ : Outstanding Shares = 1000 ,You Own 100 shares. Hence your ownership =10%. XYZ issues additional 200 shares, now your ownership= 8.3% ((100/1200) x 100). To retain your10% interest, you will have to buy another 20 shares of XYZ. What can XYZ offer you?

Warrant : Warrant is a security that entitles the holder to buy stock of the company that issued it at a specifiedprice, which is usually higher than the stock price at time of issue.

The investors purchasing warrants cannot make an immediate profit from using them to buy stock. Forthe warrants to become valuable, the common stock must appreciate in value. Warrants are thereforeissued to enhance the future value of the stock to the holder.

ADR/ GDR: An American Depositary Receipt (or ADR) represents ownership in the shares of aforeign company trading on US financial markets. The stock of many non-US companies trades on USexchanges through the use of ADRs. ADRs enable US investors to buy shares in foreign companieswithout undertaking cross-border transactions.


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Stock Index

A stock market index is a listing of stock and a statistic reflecting the composite value ofits components.

Examples: Dow Jones Industrial Average (DJIA) NYSE Composite Index S&P 500 Composite Stock Price Index Nasdaq-100 Index

Uses: Stock index is an easy means of tracking the stock market. Index shows how good or the bad is the

market. Stock index is used to measure the performance of the investment portfolio

Suppose an Index contains two stocks, A and B. A has a market capitalization* of Rs 1000 crore and Bhas a market capitalization of Rs 3000 crore. Then we attach a weight of to the movements in A and3/4 to the movements in B.

*Market Capitalization - It is company's outstanding shares multiplied by the current market price of one share


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Stock Quotations

The following is an example of how a hypothetical stock might be quoted in a financial newspaper-

52 week High/Low Stocks highest/Lowest price during past year

HYP Stocks ticker symbol

Div Indicates dividend per share paid to shareholders based on last dividend declaration

Yield % - It is the dividend yield i.e annual dividends per share divided by current price per share.

P/E Price earning ratio which is the current price per share divided by earnings per share (EPS) for last year.

(EPS is portion of companys profit allocated to each outstanding shares. Vol 100s Refers to the total amount of shares traded during previous day listed in 100s. Hence in the above table, therewere 105200 (1052 * 100) HYP shares traded.

High/Low Refers to the highest/lowest price paid for the stock the previous day.

Close Last traded price recorded when market closed on the previous day.

Chg Refers to the changes in the stocks prices from the previous day closing price. +ve means a stock is on the up.


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Trade Execution

1) Chris decides to invest in thestock market 2) Cathy decides to sell 100shares of GE stock3) Having recd advice from NYSEmember broker , Chris decidesto purchase GE stock

4) Cathy asks her NYSE broker for aquote on GE stock

5)The two NYSE brokers obtain quotes for GE stock on exchanges electronic market datasystem

6) Chris tells his broker to purchase100 stocks of GE

7) Cathy tells her broker to sell 100stocks of GE

8)Brokers send their orders to the floor brokers and compete with other brokers to get the bestprice for their customers

9) Once the trades are executed the specialist workstation sends notice to the brokeragefirm. The transaction is reported around the world in seconds

10) Within 3 days Chris and Cathy are sent confirmation of their trades by the brokerage firms

11) Chris settles his a/c within 3 days by submittingpayment to his brokerage a/c.

12) Cathys a/c is credited within 3 days with theproceeds from the sales of the shares minus anycommissions.


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What questions do you have?

Question and Answer


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Introduction to Debt Instruments


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Introduction

What is a Debt Instrument? Debt instrument represents a contract whereby one party lends money to another on pre-

determined terms with regards to rate and periodicity of interest, repayment of principal amount bythe borrower to the lender. This in financial term is usually called as Bond.

Why Debt Instruments?For Companies Companies can raise large amount from the public by issuing debt instruments than taking loans

from the banksFor Investors Debt Instruments are more secured than the Equities as the returns are definite for most of the time Debt instruments act as risk less investment option for people seeking retirement benefits

When money is needed for a specific purpose in the relatively near future, fixed-income securitiesare likely the best investment because they earn interest and they have guaranteed return of theinvested amount.

Risk Profile: Low. Less risky than equities because the investor knows the exact amount thatwill be paid at the end of maturity.
http://www.investopedia.com/terms/t/treasurybond.asphttp://www.investopedia.com/terms/t/treasurybond.asp


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Types of Bonds

Government Bonds are issuedby the Central Government andare highly secured. Thedifferent types of Bonds basedon the maturity are: Bills - debt securities maturingin less than one year. Notes - debt securitiesmaturing in one to 10 years. Bonds - debt securitiesmaturing in more than 10 years.

Government bonds

These Bonds are issued by thelocal governments for thedevelopmental purposes.Returns from these bonds areusually tax free..

Municipal Bonds

Bonds that are issued by thecorporate and usually carry

higher interest rate..

Corporate bonds

This is a type of bond thatmakes no coupon payments butinstead is issued at aconsiderable discount to parvalue..

Zero Coupon bonds


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Features of a Bond

Principal It is the amount that issuer borrows and agrees to repay the bondholder on the maturitydate. Also referred as par value, face value or maturity value. The denomination of principal variesdepending on the life of the bond.

Coupon As the bondholder effectively lends the bond issuer a sum of money, the issuer must offer arate of interest as a form of compensation. This rate of interest usually comes in the form of regularpayment referred as Coupon.

Coupon payments are generally made on a semi-annual or annual basis depending on thetype of bond. Though bonds pay a fixed interest through their life, floating rate notes (FRNs) are anexception. The coupon rates of these fluctuate in line with a pre-determined market reference rate.

Also another exception is Zero coupon bonds which we will cover later.

Price It is dependent on number of factors including market current rates, credit quality, maturity andsupply demand. Newly issued bonds generally sell at (or near) their par value.

The bonds that trade above their par value is said to trade at a premium and those that tradebelow their par value are said to trade at a Discount.


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Features of a Bondcontinued

Maturity Maturity of a bond is the length oftime before it expires.Debt Securities with a term of less thanone year are generally classified as Money Marketinstruments. Bonds are generally issued withmaturity up to 10 years. Bonds with maturities ofless than 10 years are referred to as Notes insome markets.

The longer the term to maturity of a

bond, the greater the yield required by investors aslonger term bonds are more exposed to factorsadversely affecting their price.

Yield The yield is the rate of return received from investing in the bond and is based on the price paidfor the bond and the coupon (interest) payment.

Current Yield = Annual coupon/Price

Example If you buy a bond with a face value of $1,000, a coupon of 8%, and a maturity of 10 years.

What is your return?

1. You will receive a total of $80 ($1,000*8%) of interest per year for the next 10 years.

2. If the interest payment is semi-annually, you'll receive two payments of $40 a year for 10 years.

3. When the bond matures after a decade, you'll get your $1,000 back.


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Features of a Bondcontinued

Today Two years later

For example, imagine Harry buys abond for USD 1000. It has a 10 yearmaturity and pays interest of 5% per

year.

Two years later, interest rates haverisen and the bond issuer is nowissuing similar bonds with a coupon of

8%

What effect do you think the risein Interest rates will have on theyield on Harrys bond?

As a result, Harry will have to sell the bond for a lower price that will offer buyers the sameyield as if they purchased a new bond from the issuer.

If Harry wants to sell this bond,will you as an investor pay USD1000 for a bond with a 5%coupon when a new bond fromthe same issuer is available withan 8% coupon?

As the above exampleillustrates, the yield andprice of a bond are

inversely related wheninterest rates rise, bondprices fall and vice versa.

Yield to maturity YTM is an enhanced measure which takes into account the following -

- Coupon payments on the bond all the way to maturity- Time value of money- any capital gain/loss that will be realized by holding the bond until maturity


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Credit Rating

An assessment of the credit worthiness of individuals and corporations. It is based upon the

history of borrowing and repayment, as well as the availability of assets and extent of liabilities.

Measuring the ability and willingness of an entity - which could be a person, a corporation, asecurity or a country - to keep its financial commitments or its debt, credit ratings are essentialtools to make some investment decisions.

There are three top agencies that deal in credit ratings for the investment world. These are:

Moody's, Standard and Poor's (S&P's) and Fitch IBCA.

Rating Chart Moodys and S&P


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Question and Answer


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Introduction to Derivatives (Forwards and Futures)


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Introduction

Derivatives are synthetic instruments

They derive value from an underlying asset class

Asset classes range from financial instruments to commoditiesto even classes such as weather and industrial effluents

However the common underlying theme of derivatives is thatthey are leveraged products

The derivative market has its own dynamics

This is because the participants in the derivative market do not always hold positions in the underlyinginstrument and have different intentions on their positions.

Exchange-traded derivative- Is listed and traded on an organized derivatives exchange, with theexchange acting as an intermediary (central counterparty) to the transaction.

OTC derivative- Is a customized, privately negotiated contract that is traded directly betweencounterparties, without going through an exchange or other intermediary.


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Types of Derivatives

Equity DerivativesUnderlying is equity (Individual or group of equity stocks)

Interest Rates DerivativesUnderlying can be bonds, debt securities etc

Currency DerivativesThese are currency pairs

Commodities DerivativesUnderlying are different commodities like gold, silver, steel, food grains and even spices.

Exotic DerivativesWeather Derivatives-Underlying is the weather of a particular area


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Classification of Derivatives

Forwards

Futures

SwapsOptions


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Derivatives Applications and Risks

Some of the most important uses of Derivatives are-

Hedging- Derivatives provide an efficient method for end users to better hedge and manage theirexposures to fluctuations in market prices/rates. Hedging generally involves entering into a transactionwhere the gains/losses from the 'hedge' will offset the gains/losses in the 'core' position.

Speculation- Derivatives can be used by speculators who are simply looking to make profits if an assetprice moves in the direction expected.

Arbitrage- Arbitrage is an attempt to make risk-free profits from temporary price discrepancies that mayexist within or between markets.

Risks Associated with DerivativesDerivatives are distinctly more complex than traditional financial instruments, such as stocks, bonds, loans,bank deposits, and so on. Derivatives risks are not 'fundamentally different' to those that exist anyway infinancial markets (principally market, credit, and operational risk) however the manner in which these risksmanifest themselves in derivatives transactions can be significantly different.


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Forwards

Features of Forward Contract

Forward contracts are traded in the over-the-counter (OTC) market and the onus is on both theparties to implement the contract.

Credit Risk is there as it is an OTC trade

The buyer (long position) of a forward contract isobligated to:

a. Take delivery of the asset at the maturitydate.

b. Pay the agreed-upon price at the maturitydate.

The seller (short position) of a forward contract isobligated to:

a. Deliver the asset at the maturity date.b. Accept the agreed-upon price at the

maturity date

Forward Contract - A forward contract is a customizedcontract between the buyer and the seller wheresettlement takes place on a specific date in future at aprice agreed today.

Now 6 Months Later

Spot Price- The spot price is the price of an asset forimmediate delivery.

Now 2 Days Later


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Futures

Futures contract is a standardized contract, traded on afutures exchange, to buy or sell a certain underlyinginstrument at a certain date in the future, at a specifiedprice.

Features

The future date is called the delivery date orfinal settlement date .

The pre-set price is called the futures price .

The price of the underlying asset on the deliverydate is called the settlement price

Futures contract are settled on the Mark toMarket basis and hence credit risk is minimal

Now 3 Months Later


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Introduction to Options


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Option

Options are financial instruments that convey the right, but not the obligation, to engage in a future

transaction on some underlying security. It can be exchange traded or over-the counter (OTC).

Example-

Harry is positive about the WidgetCorp stock which iscurrently trading at USD 100.However, he is highly riskaverse. In view of this uncertainty, he pays USD 5 toSally for an option. This option gives him right but not

the obligation to buy one stock of WidgetCorp for USD110 in a weeks time.

At the end of the week, Harry can exercise the option. He will do so on the basis of three possiblesituations-

1. Stock price rises - If the stock price goes up to USD 120, say, then Harry will exercise hisoption i.e he will buy the share from sally at USD 110 and then he can either hold the positionor sell it in the market at 120USD thereby making a profit of USD 5.

2. Stock price falls - If the stock price falls to USD 90, say, then Harry will ignore the option. Hecan directly buy a share from the market or leave the stock as it is.

3. Stock price rise slightly - If the stock price rises to 111, say, then Harry will still exercise hisoption as this would be still cheaper for him to go to market and spending USD 111.


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Option Terminology

Call Option A call option gives the holder the right but not the obligation to buy an asset by acertain date for a certain price. Put Option A Put option gives the holder the right but not the obligation to sell an asset by acertain date for a certain price.

Option price/premium Option price/premium is the price which the option buyer pays to theoption.

Expiration Date The date specified in the options contract is known as the expiration date , theexercise date, the strike date or the maturity

Strike Price The price specified in the options contract is known as the strike price or the exerciseprice.Buyer of the option The buyer of an option is the one who by paying the option premium buysthe right but not the obligation to exercise his option on the seller/writer

Writer of the option The writer of a call/put is the one who receives the option premium and is

thereby obliged to sell/buy the asset if the buyer exercises on him.Long ( or Long Position) The buying of an options contract. For example, an owner of shares inMcDonald's Corp. is said to be "long McDonald's" or "has a long position in McDonald's".

Short ( or Short Position) The sale (also known as writing) of an options contract.


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Options

Options and Financial Markets

Options are found in almost every major financial market.

Securities : Call and Put options can be purchased on shares traded on all major stockexchange. Options can also be bought on government and corporate bonds.

Indexes and Futures Contract- Options can be bought on indexes (e.g. Equity index- S&P500)

Commodities - Options are available on both soft commodities such as grain and hardcommodities such as precious metal.

FX-Options can be bought to hedge against currency fluctuations.

Hence, considering the above example again

- Harry is the buyer of the option and Sally the writer .

- The premium Harry pays Sally for the option is USD 5.

- The strike price of the option is USD 110.

- The expiration date for the option is one week from today.

- Harry holds the long position by buying the option and sally holds the shortposition by selling the option.


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Option Styles

European Option - an option that may only beexerc ised on expiration

American Option - an option that may beexerc ised on any trading day on or before expiration

Bermudan Option : An option that may beexerc ised only on specified dates on or beforeexpiration


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Question and Answer

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Introduction to Capital Markets.ppt