Derivatives futures and options project
Not a MyNAP member yet? Register for a free account to start saving and derivatives futures and options project special member only perks. Among the most important changes in world financial markets over the past two decades has been the emergence of a myriad of derivatives futures and options project and rediscovered financial instruments in the form of derivative products.
Financial derivatives include swaps, options, forwards, and futures for interest rates, currencies, stocks, bonds, indexes, and commodities. Many derivative transactions are international, involving residents of different countries, and they are often conducted in multiple currencies. Their rapid growth can be attributed to the need of investors and borrowers to manage risks in an environment of fluctuating exchange rates, interest rates, and commodity prices.
Adverse changes in exchange rates, for example, can eliminate a firm's overseas profits; commodity price fluctuations can increase input prices of production; and changes in interest rates can put pressure on a firm's financial costs. The wave of financial deregulation, technological innovation, and competition among market participants has further facilitated the development of derivatives.
In addition, the cost-saving features of these products and the flexibility they afford investors and borrowers have fueled their expansion. They have been used not only for hedging, but also for trading activities. Particularly since the early s, derivatives have come to account for a significant share of international financial transactions.
Since derivative products appear in numerous forms and. This chapter explores the revolutionary changes that financial derivatives have brought to world financial markets and their implications for the collection of accurate, timely, and relevant data for public and private decision making.
It is important to understand the basic features and uses of these instruments and how they have affected the coverage of the existing balance-of-payments data and their interpretation.
Financial derivatives are secondary instruments, the values of which are dependent on changes in the value of the underlying financial instrument or commodity. They are generally linked to a primary financial instrument or an indicator such as foreign currencies, government bonds, corporate equities, certificates of deposit, stock price indices, and interest rates or to a commodity such as gold, petroleum, copper, wheat, coffee, and cattle. They usually do not result in a transfer of the derivatives futures and options project primary instrument or commodity at the inception of a contract.
Instead, they usually entail an exchange between the counterparties to the contract at some future date. Derivatives can generally be classified as either ''option-like" or "forward-like. Forwards are a derivatives futures and options project to purchase or sell an underlying financial instrument or commodity at a specified price at a future date. Derivative products can take the form of one or a combination of several basic financial contracts:. A financial option contract gives the purchaser of the option the right to buy, derivatives futures and options project, or exchange specific financial instruments at a fixed or determinable price called the exercise or strike price at the exercise of the option.
Examples include currency, interest rate, stock, index, and commodity options. A warrant can be considered as a type of option: A financial forward derivatives futures and options project is one in which two parties agree to exchange specific financial instruments at a future date on predetermined terms. Examples are foreign exchange forwards and interest rate forwards. A swap contract is the binding of two parties to exchange two different payment streams over time, the payments being tied, at least in part, to subsequent and uncertain market developments.
Examples include swap contracts on interest rates and foreign currencies, equities, and commodities notably gold and petroleum products. A swap can be considered as a series of financial forwards, except that the underlying credit risks of the two types of instruments can be different. A futures derivatives futures and options project requires the delivery of a specified amount of an underlying asset at some future date at a price agreed on the day the contract is made. Examples are currency futures, interest rate futures, index futures, and commodity futures.
Futures contracts can also be considered as a form of forward contract traded on public exchanges, except that the underlying credit risks derivatives futures and options project the two types of contracts can be different. A primary purpose of these secondary instruments is to hedge against exposure to risk. Most, therefore, are designed to transfer one or more of the financial risks inherent in an underlying primary financial instrument or commodity to a third party willing to accept the risks.
The counterparty buyer or seller to the transaction assumes the risk either for speculative purposes or to hedge an offsetting exposure of its own.
Some derivative instruments are not new but have been rediscovered and promoted since the early derivatives futures and options project. Others are new products designed to derivatives futures and options project borrowers and investors to deal with volatility in exchange rates, interest rates, and stock and commodity prices.
In principle, portfolio managers can realign financing risks through cash markets without using financial derivatives. For example, borrowers and investors can diversify their foreign exchange risks by holding assets and liabilities in different currencies. A company that wants to lock in an attractive interest rate to meet future financing needs can issue the debt in the cash market before the funding is needed. In practice, however, the transaction costs of cash market strategies can be daunting, and their liquid.
Also, there may be regulatory barriers and tax disincentives. When used prudently, derivatives can offer cheaper alternatives than cash market products to achieve the same hedging or trading objectives. Derivatives are also designed to provide borrowers and investors with flexibility to unbundle and hedge different risks separately. In the case of foreign exchange futures contracts, a U. This strategy will avoid the risk of loss if exchange rates move against the firm before payments for the goods are received.
Furthermore, financial derivatives can be combined with a debt issuance to unbundle the financial price risk from other risks inherent in the process of raising capital. By coupling its bond issues with swaps, for example, a firm can separate interest rate risk from traditional credit risk Rawls and Smithson, Yet another use of derivatives relates to home mortgages.
Innovative financial derivatives have been one means to support residential refinancings in the United States. Duringas U. Prepayments reduced the income stream of mortgage holders.
To hedge against bursts of prepayment exposure, some mortgage bankers and other financial institutions were able to transfer prepayment risk by turning to reversed indexed principal notes see Feigenberg et al.
Such instruments are designed to extend cash flows to financial institutions as interest rates decline and to shorten cash flows as interest rates rise. The more prevalent approach to handling prepayment risk, however, has been through the securitization of mortgage assets through collateralized mortgage obligations. Derivatives such as derivatives futures and options project and options tend to involve lower transaction costs, and at times they offer higher liquidity than cash markets for example, through index trading.
This higher liquidity is useful for investors who can also use derivatives to change their risk exposures—by hedging against downside risk, swapping bond coupons for derivatives futures and options project dividends, diversifying into foreign markets—without having to buy or sell the underlying securities. An investor holding a long-term bond can protect asset value through a period of expected interest rate turbulence by a swap with floating rate income during that period, rather than selling the holding outright.
Active participation in derivatives markets requires capital strength, in-depth market information, and technical expertise. Consequently, derivatives futures and options project instruments, and the rights and obligations underlying them, are for the most part created by financial enterprises—either acting as agents or brokers in setting up contracts between two other parties or as principals in contracting with a customer. That is, activities in financial derivatives are largely conducted at the "wholesale" rather than at the "retail" level.
An indication of the institutional nature of swap transactions comes from the International Swap Dealers Association ISDAan international group of commercial, investment, and merchant banks and other swap dealers: Major users of financial derivatives include large business enterprises, banks, savings associations, insurance companies, institutional investors, government agencies, and international organizations.
Derivatives can be traded on organized exchanges or they can be over-the-counter OTC contracts. OTC instruments are generally customized to clients' needs; they often specify commodities or instruments and terms not offered on exchanges.
OTC market transactions are generally negotiated over the telephone before being confirmed in writing. As in the case of cash instruments, it is not uncommon for financial derivatives to be cross-listed in international capital markets. Through arbitrage, these secondary instruments link different derivative markets, as well as the cash markets. There are major risks in the use of derivatives futures and options project both for individual firms that are users or dealers in derivatives and potential risks for the financial system as a whole.
At the level of the individual firm or other user, there have been several recent cases of major financial losses through the use of derivatives in often complex and highly leveraged transactions.
Unlike exchange markets, in which orders are brought to a central derivatives futures and options project a "floor" to be executed, OTC orders are handled by dealers working over the telephone or through a computerized order execution system.
The need for a more disciplined approach by users of derivatives and for greater senior management attention and responsibility has been recognized, and a set of "best practices" for the handling of these instruments proposed by industry sources through a report of the Group of Thirty The issue of systemic risk, that is, the potential impact of derivatives on the financial system as a whole, is also a subject of debate.
Questions have been raised about possible scenarios in which derivatives might be a source of a widespread disturbance in the financial system. One area of concern has focused on the high degree of concentration of derivatives' trading in a small number of institutions: A second area of concern has centered on the issue of whether certain risk management techniques, such as dynamic hedging of options positions—techniques that lead market participants to buy assets when prices are rising and sell when prices are falling—can disturb markets by exacerbating volatility.
From a limited beginning in financial forward and futures contracts in the late s have come a plethora of currency, interest rate, and commodity options, futures, and swaps instruments and many combinations of them.
Among derivatives, swaps have grown the fastest in recent years. Most swap activity to date has been concentrated on interest rates. According to market participants, swaps are attractive as a way to either hedge against existing risks or transform exposures from one source of risk to another. In addition, financial swaps are simple in principle and unusually versatile in practice.
They are therefore revolutionary, especially for portfolio management. A swap coupled with an existing asset or liability can radically modify effective risk and return. Swaps have been a powerful force in integrating global capital markets.
Increasingly, they link currency and money markets and erode price discrepancies that result from differences of liquidity and credit standing across markets. Globally, the key uses of swaps lie in the arbitrage of yield and credit differentials across borders, the management of interest and exchange rate risk, derivatives futures and options project the global diversification of funding and investing.
Comprehensive statistics are not available on the levels derivatives futures and options project activity in derivative instruments, but several sources do collect data on these instruments: The Bank for International Settlements BIS publishes estimates of market size for selected derivative financial instruments.
Estimates are in notional principal amounts. BIS estimates are based on its own calculations and data from various other sources, including the International Swap Dealers Association, futures and options exchanges worldwide, industry associations, and U. There is a very high cutoff point for these reports.
These unpublished data include the number of covered long and short call and put contracts and the number of uncovered calls and puts traded on the Chicago Board Options Exchange. These unpublished data cover the derivatives futures and options project number of contracts by brokerage firms and by general geographic distribution, but they are not distinguished by type.
The Intermarket Surveillance Group collects daily data on U. The Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency, using the Call Report, collect data on interest rate contracts, foreign exchange rate contracts, and contracts on other commodities and equities, as well as on other off-balance-sheet items.
The data are limited to derivatives transac. Lawson of the Bureau of Economic Analysis assisted with the compilation of these sources. The ISDA conducts surveys every six months on turnover and every year on outstanding positions.
Their coverage of derivative products and markets is limited, however.
You will set out targets for each trade, and interpret and evaluate the trading results derivatives futures and options project the context of the material read during the semester. Students have 12 weeks to buy, sell, short, long and cover positions on trades made during this period. One account is known as the active account where you trade regularly, while the other account is known as the passive account.
Traders will hold these stocks in their passive account for the duration of the trading period. Traders can adopt any approach in selecting these stocks. The trades made in the Active account should reflect the material demonstrated and referred to in lectures, as well as those adopted by you having read outside the material, whether it is self-interest or adopted form from previous modules. Currently, the use of technical analysis will be discussed and, therefore, should be applied and reflected in the trades made.
The report should consist of: It is recommended that students do not trade a large percentage of their cash on individual trades. This may be speculative given expected company reports, etc. The trader should state before a trade is activated the point at which they will close out positions, e.
Also, they must highlight that they will close out on or before the expiration date. Once the trade has been reversed, the graph at the date of closing out the position should also be shown to highlight the movement in price. Also, traders should buy and short a few underlyings in the futures markets while using low volumes. Due to time restrictions, not all strategies can be addressed. Any student that is adventurous is more than welcome to use other strategies, derivatives futures and options project will be acknowledged by the examiner.
It is imperative that the report is started immediately. This could possibly lead to losses, both in trades made and marks given for the assignment. Lighten up the report by reporting on: If so, change your pattern and approach to making trades regarding the above and identify if trading outcomes change for the better or worse.
Any problems with Stocktrak, please note them in your report and email Stocktrak about them. These are considered your broker and trading platform. Make up your own if you like, but always stick to the rules you adopt. And if the rules that you invent or adopt are bad ones, then change them. If you do not, you could be falling in love with your stock! Markets may have reached its peak and it could be too late to get in.
It is also possible to profit in a sideways market. If it looks too good to be true, it usually is! Seek fresh air like walking the dog. Give yourself some time. Never start trading on an emotional wave of any kind. Derivatives futures and options project need to be switched on, calm and alert. Give yourself time to learn. Babies do not give up trying to walk or talk after a few unsuccessful attempts.
Follow their example and persevere and prepare yourself to be rewarded richly from this process of learning. Get familiar with a few techniques at a time, especially the basic ones first.
StockTrak will be used to simulate the trading experience and there derivatives futures and options project countless publications and web sites to help you build up your knowledge database.
It is through extreme experiences that you find out a lot about yourself in good times and bad. Blaming the stock, the teacher or the tipster only wastes energy and stops you asking what more you can do to improve your technique, your derivatives futures and options project and your performance.
By doing this you must know your: These questions will lead you to formulating a trading plan. The larger the loss, the more egg on your face.
Do not wait in vain for the market to turn around and bail you out. Studies exist that indicate that staying too long with a losing position was one of the major derivatives futures and options project that speculators lost money. Willingness to close out a losing position early was identified as the mark of a successful futures trader. Used by some of the most prestigious universities: Report Contents The report should consist of: The market is more powerful than any one stock.
Criteria for successful trading: To ask which one to choose is a very personal question that consists of a number of issues:
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