Introduction Chapter Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.1 Introduction Chapter 1
2 The nature of derivatives a derivative is an instrument whose value depends on the values of other more basic underlying variables Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.2 The Nature of Derivatives A derivative is an instrument whose value depends on the values of other more basic underlying variables
3 Examples of Derivatives · Forward contracts Futures Contracts Swaps Options Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.3 Examples of Derivatives • Forward Contracts • Futures Contracts • Swaps • Options
Derivatives markets Exchange traded Traditionally exchanges have used the open outcry system, but increasingly they are switching o electronIc trading Contracts are standard there is virtually no credit risk Over-the-counter OTC) A computer-and telephone-linked network of dealers at financial institutions corporations and fund managers Contracts can be non-standard and there is some small amount of credit risk Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.4 Derivatives Markets • Exchange traded – Traditionally exchanges have used the openoutcry system, but increasingly they are switching to electronic trading – Contracts are standard there is virtually no credit risk • Over-the-counter (OTC) – A computer- and telephone-linked network of dealers at financial institutions, corporations, and fund managers – Contracts can be non-standard and there is some small amount of credit risk
5 Ways Derivatives are Used To hedge risks To speculate(take a view on the future direction of the market) To lock in an arbitrage profit To change the nature of a liability To change the nature of an investment without incurring the costs of selling one portfolio and buying another Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.5 Ways Derivatives are Used • To hedge risks • To speculate (take a view on the future direction of the market) • To lock in an arbitrage profit • To change the nature of a liability • To change the nature of an investment without incurring the costs of selling one portfolio and buying another
1.6 Forward contracts A forward contract is an agreement to buy or sell an asset at a certain time in the future for a certain price( the delivery price) It can be contrasted with a spot contract which is an agreement to buy or sell immediately It is traded in the otc market Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.6 Forward Contracts • A forward contract is an agreement to buy or sell an asset at a certain time in the future for a certain price (the delivery price) • It can be contrasted with a spot contract which is an agreement to buy or sell immediately • It is traded in the OTC market
7 Foreign Exchange Quotes for GBPon aug 16, 2001(See page 3) Bid Offer Spot 1.4452 1.4456 1-month forward 1.4435 1.4440 3-month forward 1.4402 1.4407 6-month forward 1.4353 1.4359 12-month forward.4262 1.4268 Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.7 Foreign Exchange Quotes for GBP on Aug 16, 2001 (See page 3) Bid Offer Spot 1.4452 1.4456 1-month forward 1.4435 1.4440 3-month forward 1.4402 1.4407 6-month forward 1.4353 1.4359 12-month forward 1.4262 1.4268
18 Forward Price The forward price for a contract is the delivery price that would be applicable to the contract if were negotiated today (i.e, it is the delivery price that would make the contract worth exactly zero The forward price may be different for contracts of different maturities Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.8 Forward Price • The forward price for a contract is the delivery price that would be applicable to the contract if were negotiated today (i.e., it is the delivery price that would make the contract worth exactly zero) • The forward price may be different for contracts of different maturities
19 Terminology The party that has agreed to buy has what is termed a long position The party that has agreed to sell has what is termed a short position Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.9 Terminology • The party that has agreed to buy has what is termed a long position • The party that has agreed to sell has what is termed a short position
1.10 Example(page 3) On August 16, 2001 the treasurer of a corporation enters into a long forward contract to buy f1 million in six months at an exchange rate of 1.4359 This obligates the corporation to pay $1, 435, 900 for f1 million on February 16.2002 What are the possible outcomes? Options, Futures, and other Derivatives, 5th edition 2002 by John C. Hull
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 1.10 Example (page 3) • On August 16, 2001 the treasurer of a corporation enters into a long forward contract to buy £1 million in six months at an exchange rate of 1.4359 • This obligates the corporation to pay $1,435,900 for £1 million on February 16, 2002 • What are the possible outcomes?