Professional Documents
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MANAGEMENT
PG 2016 TRIMESTER V
Outline
Introduction
Forward Contracts
Futures Contracts
Options
Swaps
2
Objectives
This segment
Introduces the major classes of derivative securities
Forwards
Futures
Options
Swaps
Discusses their broad characteristics and points of
distinction.
Discusses their uses at a general level.
The objective is introductory: to lay the foundations for
the detailed analysis of derivative securities.
3
Derivatives
4
Basic Distinctions - I
5
Basic Distinctions II
7
Risk-Management Roles - II
8
Outline for Remaining Discussion
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Forward Contracts
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Forward Contracts
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Forwards: Characteristics
12
The Role of Forwards: Hedging
13
BUT...
14
An Example
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Forward Contracts: Payoffs
Forward to buy XYZ stock at F = 100 at date T.
Let ST denote the price of XYZ on date T.
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Forwards are "Linear" Derivatives
The forward price is a breakeven delivery price: it is the delivery price that would make the contract have zero value to both parties at inception.
Intuitively, it is the price at which neither party would be willing to pay anything to enter into the contract.
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The Forward Price and the Delivery Price
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The Forward Price
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Futures Contracts
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Futures Contracts
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Forwards vs. Futures
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The Futures Price
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Options
25
Basic Definitions
26
Broad Categories of Options
Exchange-traded options:
Stocks (American).
Futures (American).
Indices (European & American)
Currencies (European and American)
OTC options:
27
Options as Financial Insurance
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Put Options as Insurance: Example
Cisco stock is currently at $24.75. An investor plans to sell Cisco
stock she holds in a month's time, and is concerned that the
price could fall over that period.
Buying a one-month put option on Cisco with a strike of K will
provide her with insurance against the price falling below K.
For example, suppose she buys a one-month put with a strike of
K = 22.50.
If the price falls below $22.50, the put can be exercised
and the stock sold for $22.50.
If the price increases beyond $22.50, the put can be
allowed to lapse and the stock sold at the higher price.
In general, puts provide potential sellers of the underlying with
insurance against declines in the underlying's price.
The higher the strike (or the longer the maturity), the
greater the amount of insurance provided by the put.
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Call Options as Insurance: Example
31
Swaps
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What are Swaps?
33
Categories of Swaps
35
What do Swaps Achieve?
36
What do Swaps Achieve?
37
Linking Different Markets
Similarly:
Interest-rate swaps provide a link between different
interest-rate markets, for example, the fixed-rate at
which floating-rate exposure can be converted to fixed-
rate exposure.
Currency swaps provide a link between interest-rate
markets indifferent currencies, for example, the EUR
fixed rate at which USD floating-rate exposure can be
converted to EUR fixed-rate exposure.
39
Swaps in this book
40
Derivatives and Risk-
Management: Some Comments
41
Derivatives and Risk-Management
42
A Simple Example
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Comparing the Alternatives
44
The Alternatives Compared
The table below presents the outcomes (in US$) under the three
alternatives in two scenarios:
A "low" exchange rate (relative to the locked-in rate) of
$0.9928/.
A "high" exchange rate of $1.0728/.
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The Alternatives Compared
46
The Best Alternative?
47
Appendix: Interest-Rate
Conventions
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Interest-Rate Convention
49
Moving Between Conventions
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Two Specific Conventions
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ContinuousCompounding
52
Money-Market Convention
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Moving Between Conventions
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Moving Between Conventions
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Moving Between Conventions
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