22-09-2012, 03:54 PM
BASICS OF DERIVATIVES
Bacics of Derivatives.pdf (Size: 1.75 MB / Downloads: 178)
Risk
Goal of risk management : to maximize the value
of the firm by reducing the negative potential
impact of forces beyond the control of
management.
four basic approaches to risk management: risk
avoidance, risk retention, loss prevention and
control, and risk transfer.
Derivatives- financial instruments whose
value depends on/derives from some
underlying variable(asset).
Used for changing the risk exposure.
Hedging
When the firm reduces its risk exposure
with the use of derivatives, it is said to be
hedging.
Future v/s FORWARD
the seller can choose to deliver the
commodity on any day during the delivery
month
futures contracts are traded on an
exchange whereas forward contracts are
generally traded off an exchange.
the prices of futures contracts are
marked to the market on
a daily basis.
OPTIONS
Options are special contractual
arrangements giving the owner the
right to buy or sell an asset at a fixed
price anytime on or before a given
date.
they give the buyer the right, but not
the obligation to exercise the
contract.
CALL OPTIONS
A call option gives the owner the right to
buy an asset at a fixed price during a
particular time period
The Value of a Call Option at Expiration
If the stock price is greater than the
exercise price, we say that the call is in the
money
The payoff of a call option at expiration is
1.If Stock Price Is Greater Than Strike price
Call-option value=Stock price-Strike price
SELLING OPTIONS
An investor who sells (or writes) a call
on common stock promises to deliver
shares of the common stock if required
to do so by the call-option holder
the seller loses money if the stock price
ends up above the exercise price and he
merely avoids losing money if the stock
price ends up below the exercise price
Why would the seller of a call place
himself in such a precarious position?