Derivative securities Quanwei cao Department of Finance TSinghua University
Charles Cao 1 Derivative Securities Quanwei Cao Department of Finance Tsinghua University
1. Introduction Summary Introduction to derivatives Futures Contracts Underlying Assets Forward contracts Types of Traders Charles cao
Charles Cao 2 1. Introduction ◼ Summary ◼ Introduction to Derivatives ◼ Futures Contracts ◼ Underlying Assets ◼ Forward Contracts ◼ Types of Traders
What is a derivative? Futures options and swaps aa derivative is a financial contract which has a value determined by the price of something else Charles cao
Charles Cao 3 What is a Derivative? ◼ Futures, options and swaps ◼ A derivative is a financial contract which has a value determined by the price of something else
Example Your family grows corn Your friend 's family buys corn to mil into cornmeal a bushel of corn is not a derivative a It is a commodity Charles cao
Charles Cao 4 Example ◼ Your family grows corn ◼ Your friend’s family buys corn to mill into cornmeal ◼ A bushel of corn is not a derivative ◼ It is a commodity
Example You enter into an agreement with your friend that says: If the price of a bushel of corn in one year is greater than $3, you will pay your friend $1 If the price of corn is less than $3, the friend will pay you $1 This is a derivative Charles cao 5
Charles Cao 5 Example ◼ You enter into an agreement with your friend that says: ◼ If the price of a bushel of corn in one year is greater than $3, you will pay your friend $1 ◼ If the price of corn is less than $3, the friend will pay you $1 ◼ This is a derivative
Example Derivatives provide insurance You earn $1 if your family s corn sells for a low price this supplement your Income Your friend earns $1 if the corn his family bought is expensive this offset the high cost of corn Charles cao 6
Charles Cao 6 Example ◼ Derivatives provide insurance ◼ You earn $1 if your family’s corn sells for a low price; this supplement your income ◼ Your friend earns $1 if the corn his family bought is expensive; this offset the high cost of corn
What is a derivative? Derivatives can be thought of as bets But the bet hedges you both against unfavorable outcomes The contracts has reduced risk for both of you Investors can use derivatives to speculate on the price of corn Key point: how it is used Charles cao
Charles Cao 7 What is a Derivative? ◼ Derivatives can be thought of as bets ◼ But the bet hedges you both against unfavorable outcomes ◼ The contracts has reduced risk for both of you ◼ Investors can use derivatives to speculate on the price of corn ◼ Key point: how it is used
Use of derivatives ■ Risk management Derivatives can be used to reduce risks Hedging Insurance(auto insurance) a speculation Derivatives can serve as investment vehicles Making bets highly leveraged Charles cao
Charles Cao 8 Use of Derivatives ◼ Risk management ◼ Derivatives can be used to reduce risks ◼ Hedging ◼ Insurance (auto insurance) ◼ Speculation ◼ Derivatives can serve as investment vehicles ◼ Making bets highly leveraged
Use of derivatives Reduced transaction costs a Low-cost way to effect a transaction Mutual-fund mangers wish to sell stocks and buy bonds Paying fees and trading costs Futures contracts have low costs Charles cao
Charles Cao 9 Use of Derivatives ◼ Reduced transaction costs ◼ Low-cost way to effect a transaction ◼ Mutual-fund mangers wish to sell stocks and buy bonds ◼ Paying fees and trading costs ◼ Futures contracts have low costs
Futures contracts An agreement to buy or sell an asset at a specified price at a certain time in the future a Traded on exchanges e g, the Chicago Board of Trade(cbot the Chicago Mercantile Exchange(CMe) Charles cao
Charles Cao 10 Futures Contracts ◼ An agreement to buy or sell an asset at a specified price at a certain time in the future ◼ Traded on exchanges, e.g., ◼ the Chicago Board of Trade (CBOT) ◼ the Chicago Mercantile Exchange (CME)
