Note that future contract offers similar payoffs as forward contracts. However, futures contracts trade on exchanges; that is, the underlying asset and possible maturity date are clearly stated in the contract. Long exposure in a futures contract means the holder of the position is obliged to buy the underlying instrument at the contract price at expiry. The holder will make a profit if the price of the instrument goes up. o The Applications Builder consists of a number of Excel functions from which users can build their own applications. It includes a number of sample applications and enables students to explore the properties of options and numerical procedures more easily. It also allows more interesting assignments to be designed. An option contract involves two parties: the party with a long position and a short position in the option. Investors trade in contracts that have been identified in the exchange. Traditionally trading was done using the outcry system (Investors met at the exchange floor and used signals to indicate their proposed trades.) Currently, trading is done electronically through a computer. Advantages of OTC Markets over Exchanges

This program provides a better teaching and learning experience—for you and your students. Here's how: Non-linear derivatives, such as options, have an asymmetrical payoff profile. This characteristic means that the holder of the option can have limited loss (the premium paid for the option) with the potential for unlimited gain. In the case of a European call option, if the price of the underlying asset goes above the strike price, the holder can exercise the option and make a profit. If the price stays below the strike price, the holder’s loss is limited to the premium paid. This is a distinguishing feature of non-linear derivatives. The risk manager can hedge against the foreign exchange risk by buying the call option with a strike price of USD 1.1120. If in six months the exchange rate is more than USD 1.1120, the risk manager will exercise the option, getting the 10 million euros using the exchange rate of USD 1.1120.Closing out a deal prior to maturity, e.g., in an American option that can be exercised before maturity, can at times be difficult. Even more likely, bid-ask spreads could be so large as to represent a substantial cost. Operational Risk Define derivatives, describe the features and uses of derivatives, and compare linear and non-linear derivatives. Companies use derivatives to manage various risks: interest rate risk, foreign exchange risk, and commodity price changes to risk.

A futures contract is a standardized, legally binding agreement – traded in on an exchange – between two parties that specifies the price to trade a given asset (commodity or financial instrument) at a specified future date. For options, speculators only need to part with the option’s price at the onset, often just a few dollars for 100 shares worth of the underlying. However, options have asymmetrical payoffs. Going long on options can bring in significant gains, but losses are limited to the option’s price paid. In a nutshell, speculators buy assets for time and apply different strategies to benefit from price changes. Speculators trade in futures, intending to resell these contracts before maturity. They expect the futures price to move in their favor and make a profit when selling the contracts. However, there can be no guarantees that the price will move in their favor, and therefore this trading strategy is also laden with risks. If the price moves against a speculator’s position, they could suffer substantial losses. The agreed-upon price is called the forward price. The price at which the dealer wants to buy is called the bid price, while the price the dealer wants to sell is called the ask price.Margins: Daily settlements may not provide a buffer strong enough to avoid future losses. For this reason, each party is required to post collateral that can be seized in the event of default. The initial margin must be posted when initiating the contract. If the equity in the account falls below the maintenance margin, the relevant party must provide additional funds to cover the initial margin. Hedgers use derivatives to reduce or remove risk exposure. We have already discussed how hedging works above. Consider the following example where foreign exchange risk is hedged using options. A linear derivative is one whose value is directly related to the market price of the underlying variable. What does that mean? o Credit risk and credit derivatives with the key products and key issues being introduced early in the book With over 200 post-graduate students selected from a pool of top applicants world-wide, a faculty recruited from the top departments internationally, and a steady flow of distinguished visitors, we have a stimulating environment for research and learning that is on par with the best in the world.

An investor with a long position in an asset can hedge the exposure by entering into a short futures contract or buying a put option. An investor with a short position in an asset can hedge the exposure by entering into a long futures contract or buying a call option. Employees are sometimes given the option of buying shares from the company at a future date at a predetermined price to compensate them. This course covers the concepts and models underlying the modern analysis and pricing of financial derivatives. The philosophy of the course is to first provide firm foundations for understanding derivatives in general. The required technical tools will be explained carefully, allowing students to learn the language and to be able to converse with derivatives professionals. Once the tools are in place, those same tools can then be applied to any derivative. Special emphasis will be put on those derivatives that shape the modern world. A risk manager in company X (located in the U.S.) knows that his company is due to pay 10 million euros in 6 months, at the exchange rate of USD 1.1120 per euro. How can the risk manager hedge again foreign exchange risk using a call option?

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Suppose that company X enters into a long position to buy 10 million euros in six months. If the actual CAD- EUR exchange rate in six months is CAD 1.1200 per euro, calculate the profit to company X. Derivatives are majorly used to hedge or to speculate. The following are specific examples of the uses of derivatives.

There’s always the risk that a trader with instructions to use derivatives as a hedging tool will be tempted to take speculative positions, possibly in the hope of making a “kill’. Such a move can be disastrous for the firm. Options not only hedge against risk but also provide additional protection against adverse price movements. In other words, they protect against negative risk while preserving upward payoffs. In options, such as a European call option, the potential loss is capped at the premium paid, while gains can be unlimited if the underlying asset’s price moves favorably.Since the 2007-2009 financial crisis, OTC markets are, however, increasingly being regulated. Some of the regulations include: