Derivatives

underlying
futures
forward
options
forward
call option
put option
FORWARDS

long position
short position
FORWARDS
zero sum

assset to which you derive the value of the derivative

market determined
otc
contingent claims
right to buy
right to sell
no open market
look for a counterparty
can be customized
u own the contract & obligated to buy the underlying asset
u own the contract & obligated to sell the underlying asset
predetermined initially (terms of contract)
no price uncertainty
gain of 1 party is the loss of the other party

FUTURES

standardized; exchange traded

require margin deposit
3-5 % of the actual value = margin (depending on the credit wor
at the end of each trading day; new contract is made (cancels th

SWAPS

similar to forwards
series of forward contracts
otc
unregulated
common swaps: interest rate swap & currency swap)
no active derivative mraket in the PH

hedging

transfer of risk

ARBITRAGE

used to make market more efficient

FORWARD CONTRACT POSITIONS

neither party pays at contract initiation
settlement date
negative side of contract pays the positive side
delivery
short delivers underlying to long for payment of the forward price
early termination of forward
dealers
end users

ask the counter party

creates a derivative contract
a corp or institution seeking to transfer an existing risk

EQUITY FORWARD CONTRACT

notional amount
at contract date

notional
525.2 10000000

at maturity
difference
percentage
gain (for long position)

535.7
10.5
0.019992
199923.8

EX
if interest rates rise, P (fall); long loses/ short gains
LIBOR
LIBOR-based loan example

london inter bank offer rate

loan value 1M
term=30
30-day LIBOR= 6%
interest payment = 5000
total payment in 30 days

FRA

- long position
short

forward rate agreement

based on LIBOR
bet between floating and fixed rate
fixed rate
LONGgains when LIBOR> contract rate
delivers value at maturity
obligation to take a (hypothetical) a loan at the contract rate
obligation to make a (hypothetical) a loan at the contract rate

FRA EX
term
30
notional
1000000
forward rat
0.05
underlying rate
at t=
30 days
0.01

90 day LIB

0.06

2463.054 PV of earnings
FRA settlement payment to long Notional principal * (floating - forward )*(days/360)
1+ floating (days /360)
CURRENCY FORWARD CONTRACTS

FUTURES MARGIN TERMS

Initial margin
maintenance
variation
settlement price
price limits

deposited before trade occurs

always below the initial; if u are long, if underlying falls maintena
no fixed amount; funds needed to restore futures account to initi
average of trades during closing period

Marking to maarket
Ex
eurodollar futures
treasury bond futures
stock index futures

adjusting margin balance in a futures account each day for the c

s&p 500 index futures

valuee is 250 times tlevel of the index
currency futures
OPTIONS
option buyer
options seller
American options
European options

pays a premium to purchase the right

owner
writer
can be exerciseed at any time
only at expiration
MONEYNESS

Call options
In the money
at the money
out of the money

S>X
s=x
s<x

S-X > 0
s-x=0
s-x<0

Put options
In the money
at the money
out of the money

s<x
s=x
S>X

s-x<0
s-x=0
S-X > 0

compares spot price of the underlying asse

kumita ka
lugi ka

not exercise

derlying asset
derlying asset
do not pay anything at time 0

ng on the credit worthiness)

is made (cancels the old contract)

t of the forward price

xisting risk

making a loan - nagpapautang

he contract rate
the contract rate

rlying falls maintenance margins falls;

ures account to initial margin amount

t each day for the change in the futures price

the underlying asset and the exercise price

ot exercise

Vt

St - Ft

value of a forward contract at time 0 should be zero

Vo = 0

EXAMPLE
So
125.72 euros
sell the assets in 9 mos
rfr =
5.625%
forward contract pr 130.98737
140

15.42455
spot price 2 months 118.875
126.87191 126.8719

expired

123.5
7.4873674

underlying asset

forward contract
stock
stock current price
expres in
rfr
pay quarterly div
ex dividend days
day
10
102
193
283

35
300 days
0.04
0.45 dollars
0.449517
0.445095
0.440764
0.436522
1.771897

33.2281

assume 365 day year

forward contract price

34.3167

Problem 2
how to convert discreet or continuous rate
ln (1+5%)
0.04879
reive funds200 days
62.5 price
dollars div in

0.75
0.75

50 days
140

4.20% rfr
61.01596
62.40709 forward contract price
day
75
stock
forward contract prce at day 75

0.745785
0.738258
1.484043

0.744525

long

55.75 dollars
61.53396
-6.528487

term
90 days
long positi on s&p price index
1145 index
0.0175
continuously compounded
4.25%
discreet risk free rate
0.041622
converted
calculate no arbitrage forward contract
1151.634 long

55.00547

1153.168

V28=

1225 index
28 days into the contract
1225(e^-(0.175)(62/365))
1151.63(e^-(ln1.0425)(62/365))
77.84726

problem.
maturity 5 years
semiannual coupon
50
150 days into the lfe of the bond
sell the bond the day after the 4th coupon
181 days after issue
365
547
730
150 day
1010.25 it includes
rfr
0.08
day 731=
day 731
rfr
bond

49.67424
47.78395
45.98497
44.2444 187.6876 212.1479
accrued interest
bond

822.5624
929.7628
0.07
1025.375 after 1 year
34.35

w/o dividends

(62/365))

2x5
FRA
(read as 2 by 5); notation
2 months maturity
5 months entire span
3x9
FRA
90 dy libor
270 day LIBOR

0.056
0.06

determine forward rate

1.030572
0.030572
0.061144 percent
25 days into FRA; long
LIBOR rates shifted upward
65 day LIB
0.059
245 day LI
0.065

42.12645
2565
180 day LIBOR
30 days
210 day

5.75%
6.15

rate that will expire in 30 days

1.030935
FRA
0.06187
20 days after
10 day
5.45%
190 day
5.95
determine the value of FRA from point of view of long inv.
Princiaal 20M
notional
-21163

St

So((1+rA)/(1+rB))^T

(1+rA)/(1+rB)
PROBLEM
dollar/swiss
us int rate
swiss int rate

=
0.5987
5.5
4.75

(1+cnfa)/(1+cnfB)

180 day forward

correct forward price
0.600839 dollar/swiss
40 days later
current spot
same interest rate
Vt

0.65 dollars

=St/(1+rB)^T)

Ft/(1+rA)^T

0.0499

FOREXe
expect the value
rfr
US
UK
spot

of pound to increase against dollar (30 days)

5.5 rate
4.5
1.5 dollars

short or long?
go long to buy pounds
calculate the forward contract rate that will expire in 30 days
365 days
1.501175 dollars/pound
10 days passed
spot
1.53 dollars/pound
same interest rates
value of forward contract
gain
0.0295