there was a test which was based on derivatives n forex n G.

K study IRS, swaps, collars, cap price, floor price, futures n forwards

bonus shares, split, reverse split n its effect on market price and d number of shares

bond and interest rate - there was a sum on this

inflation, repo rate, slr , crr reverse repo, prime lendin rate

some accountin entries...

G.K - they asked abt rbi governer, sebi chairman, morgan stanley ceo and the differet world indices

do read abt morgan stanley in detail n do listen to d ppt d giv ...Qs will b asked from there

Answer
There is an inverse relationship between price and yield: when interest rates are rising, bond prices are falling, and vice versa. The easiest way to understand this is to think logically about an investment. You buy a bond for $100 that pays a certain interest rate (coupon). Interest rates (coupons) go up. That same bond, to pay then-current rates, would have to cost less: maybe you would pay $90 the same bonds if rates go up.

Ignoring discount factors, here is a simplified example, a 1-year bond. Let's say you bought a 1-year bond when the 1-year interest rate was 4.00%. The bond's principal (amount you pay, and will receive back at maturity) is $100. The coupon (interest) you will receive is 4.00% * $100 = $4.00. Today: You Pay $100.00 Year 1: You receive $4.00 Year 1 (Maturity): You Receive $100 Interest Rate = $4.00 / $100.00 = 4.00% Now, today, assume the 1-year interest rate is 4.25%. Would you still pay $100 for a bond that pays 4.00%? No. You could buy a new 1-year bond for $100 and get 4.25%. So, to pay 4.25% on a bond that was originally issued with a 4.00% coupon, you would need to pay less. How much less? Today: You Pay X Year 1: You Receive $4.00 Year 1 (Maturity): You Receive $100 The interest you receive + the difference between the redemption price ($100) and the initial price paid (X) should give you 4.25%: [ ($100 - X) + $4.00 ] / X = 4.25% $104 - X = 4.25% * X $104 = 4.25% * X + X $104 = X (4.25% + 1) $104 / (1.0425) = X X = $99.76 So, to get a 4.25% yield, you would pay $99.75 for a bond with a 4.00% coupon.

In addition to the fact that bond prices and yields are inversely related, there are also several other bond pricing relationships:

An increase in bond's yield to maturity results in a smaller price decline than the price gain associated with a decrease of equal magnitude in yield. This phenomenon is called convexity. Prices of long term bonds tend to be more sensitive to interest rate changes than prices of short term bonds. For coupon bonds, as maturity increases, the sensitivity of bond prices to changes in yields increases at a decreasing rate. Interest rate risk is inversely related to the bond's coupon rate. (Prices of high coupon bonds are less sensitive to changes in interest rates than prices of low coupon bonds. Zero coupon bonds are the most sensitive.) The sensitivity of a bond's price to a change in yield is inversely related to the yield at maturity at which the bond is now selling.

Bond prices and interest rates

an LBO supplement, September 1996

When interest rates rise, the prices of outstanding bonds fall; when rates fall, prices rise. Though this relation might not seem obvious at first, the reasons are fairly simple. Take this example. Say the U.S. government sells Treasury bonds when prevailing market interest rates are 8%. So, a bond with a face value of $1,000 on issue would pay $80 a year in interest - usually in two half-yearly installments of $40. But if market interest rates were to rise to 10%, then who would want to buy such a bond? So, the market price of the bond would have to fall to a level where that fixed $80 annual payment were the equivalent of a 10% annual yield - in this case, the price would have to fall to $800, so that the annual $80 payment would equal 10% of the purchase price of the bond. (Obviously, this matters only if the holder of the bond wants to sell it in the open market; if he or she wants to keep the bond to maturity, the price fluctuations exist only on paper.) Since bond prices are usually expressed at a percent of face (or "par") value, the price of the bond would be quoted at 80. Conversely, if market interest rates were to fall to 6%, the price of the bond would rise to $1,333.33 - or 133 11/32 in market jargon. U.S. stock and bond markets don't use decimal pricing. Stock prices are usually quoted in eighths of a point, though sixteenths and even thirtyseconds are used for some low-priced shares; bond prices are usually quoted in thirty-seconds. Things are actually a bit more complicated than this. A buyer who paid $800 or $1,333 for a bond and held it to maturity would get a return of $1,000 in principal. The buyer who paid a premium would have a capital loss, and the one who bought the bond at a discount from its face value would have a capital gain. So that deviation of market value from face value would have to enter into any calculations of ultimate yield ("yield to maturity," in the jargon). But these

simplified examples are enough to illustrate the basic principle of why bond prices move in the opposite direction of interest rates. When combined, price changes and interest payments are referred to as total return. Someone who bought a bond when interest rates were 8% and held it for a year as they fell to 6% would get not only the 8% interest yield, but a 33% capital gain, for a total return of 41% - not bad for a year's "work." But someone who bought a bond at 6% and held it as rates rose to 8% would suffer a sharp capital loss. Since interest rates rose for most of the period from the early 1950s through the early 1970s, the capital losses far outweighed the interest payments - and that's before adjusting for the corrosive effects of inflation. It's no wonder that rentiers, poor dears, christened bonds "certificates of confiscation" in the late 1970s. But since rates peaked in the early 1980s, bondholders have done marvelously well, enjoying one of the greatest long-term bull markets in the modern history of credit. Most bond market players do not hold bonds to maturity; in fact, the average holding period of a thirty-year U.S. Treasury bond is only about thirty days. Most bond traders are trying to make money on changes in bond prices; they like the interest payments, of course, but what they're really after is the speculative changes in prices. Despite the stodgy reputation of bond markets, a holdover from the old days when they really were sleepy, they're now among the most vigorous speculative markets in the world.
Bond and int rate At first glance, the inverse relationship between interest rates and bond prices seems somewhat illogical, but upon closer examination, it makes sense. An easy way to grasp why bond prices move opposite to interest rates is to consider zerocoupon bonds, which don't pay coupons but derive their value from the difference between the purchase price and the par value paid at maturity. For instance, if a zero-coupon bond is trading at $950 and has a par value of $1,000 (paid at maturity in one year), the bond's rate of return at the present time is approximately 5.26% ((1000-950) / 950 = 5.26%). For a person to pay $950 for this bond, he or she must be happy with receiving a 5.26% return. But his or her satisfaction with this return depends on what else is happening in the bond market. Bond investors, like all investors, typically try to get the best return possible. If current interest rates were to rise, giving newly issued bonds a yield of 10%, then the zero-coupon bond yielding 5.26% would not only be less attractive, it wouldn't be in demand at all. Who wants a 5.26% yield when they can get 10%? To attract demand, the price of the pre-existing zero-coupon bond would have to decrease enough to match the same return yielded by prevailing interest rates. In this instance, the bond's price would drop from $950 (which gives a 5.26% yield) to $909 (which gives a 10% yield). Now that we have an idea of how a bond's price moves in relation to interest-rate

changes, it's easy to see why a bond's price would increase if prevailing interest rates were to drop. If rates dropped to 3%, our zero-coupon bond - with its yield of 5.26% - would suddenly look very attractive. More people would buy the bond, which would push the price up until the bond's yield matched the prevailing 3% rate. In this instance, the price of the bond would increase to approximately $970. Given this increase in price, you can see why bond-holders (the investors selling their bonds) benefit from a decrease in prevailing interest rates

All you wanted to know about derivatives!

April 19, 2005 07:03 IST

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'By far the most significant event in finance during the past decade has been the extraordinary
development and expansion of financial derivatives. These instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it - a process that has undoubtedly improved national productivity growth and standards of living.' -- Alan Greenspan, Chairman, Board of Governors of the US Federal Reserve System. Understanding Derivatives The primary objectives of any investor are to maximise returns and minimise risks. Derivatives are contracts that originated from the need to minimise risk.

The word 'derivative' originates from mathematics and refers to a variable, which has been derived from another variable. Derivatives are so called because they have no value of their own. They derive their value from the value of some other asset, which is known as the underlying. For example, a derivative of the shares of Infosys [ Get Quote ] (underlying), will derive its value from the share price (value) of Infosys. Similarly, a derivative contract on soybean depends on the price of soybean. Derivatives are specialised contracts which signify an agreement or an option to buy or sell the underlying asset of the derivate up to a certain time in the future at a prearranged price, the exercise price. The contract also has a fixed expiry period mostly in the range of 3 to 12 months from the date of commencement of the contract. The value of the contract depends on the expiry period and also on the price of the underlying asset. For example, a farmer fears that the price of soybean (underlying), when his crop is ready for delivery will be lower than his cost of production. Let's say the cost of production is Rs 8,000 per ton. In order to overcome this uncertainty in the selling price of his crop, he enters into a contract (derivative) with a merchant, who agrees to buy the crop at a certain price (exercise price), when the crop is ready in three months time (expiry period). In this case, say the merchant agrees to buy the crop at Rs 9,000 per ton. Now, the value of this derivative contract will increase as the price of soybean decreases and vice-a-versa. If the selling price of soybean goes down to Rs 7,000 per ton, the derivative contract will be more valuable for the farmer, and if the price of soybean goes down to Rs 6,000, the contract becomes even more valuable. This is because the farmer can sell the soybean he has produced at Rs .9000 per tonne even though the market price is much less. Thus, the value of the derivative is dependent on the value of the underlying. If the underlying asset of the derivative contract is coffee, wheat, pepper, cotton, gold, silver, precious stone or for that matter even weather, then the derivative is known as a commodity derivative. If the underlying is a financial asset like debt instruments, currency, share price index, equity shares, etc, the derivative is known as a financial derivative. Derivative contracts can be standardized and traded on the stock exchange. Such derivatives are called exchange-traded derivatives. Or they can be customised as per the needs of the user by negotiating with the other party involved.

Such derivatives are called over-the-counter (OTC) derivatives. Continuing with the example of the farmer above, if he thinks that the total production from his land will be around 150 quintals, he can either go to a food merchant and enter into a derivatives contract to sell 150 quintals of soybean in three months time at Rs 9,000 per ton. Or the farmer can go to a commodities exchange, like the National Commodity and Derivatives Exchange Limited, and buy a standard contract on soybean. The standard contract on soybean has a size of 100 quintals. So the farmer will be left with 50 quintals of soybean uncovered for price fluctuations. However, exchange traded derivatives have some advantages like low transaction costs and no risk of default by the other party, which may exceed the cost associated with leaving a part of the production uncovered. Some of the most basic forms of Derivatives are Futures, Forwards and Options. Futures and Forwards As the name suggests, futures are derivative contracts that give the holder the opportunity to buy or sell the underlying at a pre-specified price some time in the future. They come in standardized form with fixed expiry time, contract size and price. Forwards are similar contracts but customisable in terms of contract size, expiry date and price, as per the needs of the user. Options Option contracts give the holder the option to buy or sell the underlying at a pre-specified price some time in the future. An option to buy the underlying is known as a Call Option. On the other hand, an option to sell the underlying at a specified price in the future is known as Put Option. In the case of an option contract, the buyer of the contract is not obligated to exercise the option contract. Options can be traded on the stock exchange or on the OTC market. History of derivatives The history of derivatives is surprisingly longer than what most people think. Some texts even find the existence of the characteristics of derivative contracts in incidents of Mahabharata [ Images ]. Traces of derivative contracts can even be found in incidents that date back to the ages before Jesus Christ [ Images ]. However, the advent of modern day derivative contracts is attributed to the need for farmers to protect themselves from any decline in the price of their crops due to delayed monsoon, or overproduction.

The first 'futures' contracts can be traced to the Yodoya rice market in Osaka, Japan [ Images ] around 1650. These were evidently standardised contracts, which made them much like today's futures. The Chicago Board of Trade (CBOT), the largest derivative exchange in the world, was established in 1848 where forward contracts on various commodities were standardised around 1865. From then on, futures contracts have remained more or less in the same form, as we know them today. Derivatives have had a long presence in India [ Images ]. The commodity derivative market has been functioning in India since the nineteenth century with organized trading in cotton through the establishment of Cotton Trade Association in 1875. Since then contracts on various other commodities have been introduced as well. Exchange traded financial derivatives were introduced in India in June 2000 at the two major stock exchanges, NSE and BSE. There are various contracts currently traded on these exchanges. National Commodity & Derivatives Exchange Limited (NCDEX) started its operations in December 2003, to provide a platform for commodities trading. The derivatives market in India has grown exponentially, especially at NSE. Stock Futures are the most highly traded contracts on NSE accounting for around 55% of the total turnover of derivatives at NSE, as on April 13, 2005. Risk Management Tools Derivatives are powerful risk management tools. To illustrate, lets take the example of an investor who holds the stocks of Infosys, which are currently trading at Rs 2,096. Infosys options are traded on the National Stock Exchange of India, which gives the owner the right to buy (call) shares of Infosys at Rs 2,220 each (exercise price), expiring on 30th June 2005. Now if the share price of Infosys remains less than or equal to Rs 2,200, the contract would be worthless for the owner and he would lose the money he paid to buy the option, known as premium. However, the premium is the maximum amount that the owner of the contract can lose. Hence he has limited his loss. On the other hand, if the share price of Infosys goes above Rs 2,220, the owner of the call option can exercise the contract, buy the share at Rs 2,220 and make profits by selling the share at the market price of Infosys. The upward gain can be unlimited. Say the share price of Infosys zooms to Rs .3,000 by June 2005, the owner of the call option can buy the shares at Rs 2,220, the exercise price of the option, and then sell it in the market for Rs 3,000. Making a profit of Rs 780 less the premium that has been paid. If the premium paid to buy the call option is say Rs 10, the profit would be Rs 770.

Looking Forward Derivatives are an innovation that has redefined the financial services industry and it has assumed a very significant place in the capital markets. However, trading in derivatives is complicated and risky. The derivatives have been blamed for the loss of fortunes at many times in history. We will look at derivatives as a vehicle of investment available to investors, risks and returns associated with them, in our next article.

Filed Under: Derivatives, Futures, Options

Derivatives contracts can be divided into two general families: 1. Contingent claims, i.e., options 2. Forward claims, which include exchange-traded futures, forward contracts and swaps A swap is an agreement between two parties to exchange sequences of cash flows for a set period of time. Usually, at the time the contract is initiated, at least one of these series of cash flows is determined by a random or uncertain variable, such as an interest rate, foreign exchange rate, equity price or commodity price. Conceptually, one may view a swap as either a portfolio of forward contracts, or as a long position in one bond coupled with a short position in another bond. This article will discuss the two most common and most basic types of swaps: the plain vanilla interest rate and currency swaps. The Swaps Market Unlike most standardized options and futures contracts, swaps are not exchange-traded instruments. Instead, swaps are customized contracts that are traded in the over-the-counter (OTC) market between private parties. Firms and financial institutions dominate the swaps market, with few (if any) individuals ever participating. Because swaps occur on the OTC market, there is always the risk of a counterparty defaulting on the swap. (For background reading, see Futures Fundamentals and Options Basics.) The first interest rate swap occurred between IBM and the World Bank in 1981. However, despite their relative youth, swaps have exploded in popularity. In 1987, the International Swaps and Derivatives Association reported that the swaps market had a total notional value of $865.6 billion. By mid-2006, this figure exceeded $250 trillion, according to the Bank for International Settlements. That's more than 15 times the size of the U.S. public equities market. Plain Vanilla Interest Rate Swap The most common and simplest swap is a "plain vanilla" interest rate swap. In this swap, Party A agrees to pay Party B a predetermined, fixed rate of interest on a notional principal on specific dates for a specified period of time. Concurrently, Party B agrees to make payments based on a floating interest rate to Party A on that same notional principal on the same specified dates for the same specified time period. In a plain vanilla swap, the two cash flows are paid in the same currency. The specified payment dates are called settlement dates, and the time between are

called settlement periods. Because swaps are customized contracts, interest payments may be made annually, quarterly, monthly, or at any other interval determined by the parties. (For related reading, see How do companies benefit from interest rate and currency swaps?) For example, on December 31, 2006, Company A and Company B enter into a five-year swap with the following terms:

Company A pays Company B an amount equal to 6% per annum on a notional principal of $20 million. Company B pays Company A an amount equal to one-year LIBOR + 1% per annum on a notional principal of $20 million.

LIBOR, or London Interbank Offer Rate, is the interest rate offered by London banks on deposits made by other banks in the eurodollar markets. The market for interest rate swaps frequently (but not always) uses LIBOR as the base for the floating rate. For simplicity, let's assume the two parties exchange payments annually on December 31, beginning in 2007 and concluding in 2011. At the end of 2007, Company A will pay Company B $20,000,000 * 6% = $1,200,000. On December 31, 2006, one-year LIBOR was 5.33%; therefore, Company B will pay Company A $20,000,000 * (5.33% + 1%) = $1,266,000. In a plain vanilla interest rate swap, the floating rate is usually determined at the beginning of the settlement period. Normally, swap contracts allow for payments to be netted against each other to avoid unnecessary payments. Here, Company B pays $66,000, and Company A pays nothing. At no point does the principal change hands, which is why it is referred to as a "notional" amount. Figure 1 shows the cash flows between the parties, which occur annually (in this example). (To learn more, read Corporate Use Of Derivatives For Hedging.)

Figure 1: Cash flows for a plain vanilla interest rate swap

Interest Rate Swap

What Does Interest Rate Swap Mean? An agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for another based on a specified principal amount. Interest rate swaps often exchange a fixed payment for a floating payment that is linked to an interest rate (most

often the LIBOR). A company will typically use interest rate swaps to limit or manage exposure to fluctuations in interest rates, or to obtain a marginally lower interest rate than it would have been able to get without the swap.

Investopedia explains Interest Rate Swap Interest rate swaps are simply the exchange of one set of cash flows (based on interest rate specifications) for another. Because they trade OTC, they are really just contracts set up between two or more parties, and thus can be customized in any number of ways. Generally speaking, swaps are sought by firms that desire a type of interest rate structure that another firm can provide less expensively. For example, let's say Cory's Tequila Company (CTC) is seeking to loan funds at a fixed interest rate, but Tom's Sports Inc. (TSI) has access to marginally cheaper fixed-rate funds. Tom's Sports can issue debt to investors at its low fixed rate and then trade the fixed-rate cash flow obligations to CTC for floating-rate obligations issued by TSI. Even though TSI may have a higher floating rate than CTC, by swapping the interest structures they are best able to obtain, their combined costs are decreased - a benefit that can be shared by both parties. Options Basics: What Are Options? An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties.

Still confused? The idea behind an option is present in many everyday situations. Say, for example, that you discover a house that you'd love to purchase. Unfortunately, you won't have the cash to buy it for another three months. You talk to the owner and negotiate a deal that gives you an option to buy the house in three months for a price of $200,000. The owner agrees, but for this option, you pay a price of $3,000. Now, consider two theoretical situations that might arise: 1. It's discovered that the house is actually the true birthplace of Elvis! As a result, the market value of the house skyrockets to $1 million. Because the owner sold you the option, he is obligated to sell you the house for $200,000. In the end, you stand to make a profit of $797,000 ($1 million - $200,000 - $3,000). 2. While touring the house, you discover not only that the walls are chock-full of asbestos, but also that the ghost of Henry VII haunts the master bedroom; furthermore, a family of superintelligent rats have built a fortress in the basement. Though you originally thought you had found the house of your dreams, you now consider it worthless. On the upside, because you

bought an option, you are under no obligation to go through with the sale. Of course, you still lose the $3,000 price of the option. This example demonstrates two very important points. First, when you buy an option, you have a right but not an obligation to do something. You can always let the expiration date go by, at which point the option becomes worthless. If this happens, you lose 100% of your investment, which is the money you used to pay for the option. Second, an option is merely a contract that deals with an underlying asset. For this reason, options are called derivatives, which means an option derives its value from something else. In our example, the house is the underlying asset. Most of the time, the underlying asset is a stock or an index. Calls and Puts The two types of options are calls and puts: A call gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires. A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires.

Futures
What Does Futures Mean? A financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. The futures markets are characterized by the ability to use very high leverage relative to stock markets. Futures can be used either to hedge or to speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk (hedge). On the other hand, anybody could speculate on the price movement of corn by going long or short using futures. Investopedia explains Futures The primary difference between options and futures is that options give the holder the right to

buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his/her contract. In real life, the actual delivery rate of the underlying goods specified in futures contracts is very low. This is a result of the fact that the hedging or speculating benefits of the contracts can be had largely without actually holding the contract until expiry and delivering the good(s). For example, if you were long in a futures contract, you could go short in the same type of contract to offset your position. This serves to exit your position, much like selling a stock in the equity markets would close a trade. CFA Level 1 - Futures vs. Forwards C. FUTURES MARKETS AND CONTRACTS Futures vs. Forwards Futures differ from forwards in several instances: 1. A forward contract is a private transaction - a futures contract is not. Futures contracts are reported to the future's exchange, the clearing house and at least one regulatory agency. The price is recorded and available from pricing services. 2. A future takes place on an organized exchange where the all of the contract's terms and conditions, except price, are formalized. Forwards are customized to meet the user's special needs. The future's standardization helps to create liquidity in the marketplace enabling participants to close out positions before expiration. 3. Forwards have credit risk, but futures do not because a clearing house guarantees against default risk by taking both sides of the trade and marking to market their positions every night. Mark to market is the process of converting daily gains and losses into actual cash gains and losses each night. As one party loses on the trade the other party gains, and the clearing house moves the payments for the counterparty through this process. 4. Forwards are basically unregulated, while future contract are regulated at the federal government level. The regulation is there to ensure that no manipulation occurs, that trades are reported in a timely manner and that the professionals in the market are qualified and honest. Characteristics of Futures Contracts In a futures contract there are two parties: 1. The long position, or buyer, agrees to purchase the underlying at a later date or at the expiration date at a price that is agreed to at the beginning of the transaction. Buyers benefit from price increases. 2. The short position, or seller, agrees to sell the underlying at a later date or at the expiration date at a price that is agreed to at the beginning of the transaction. Sellers benefit from price decreases.

Prices change daily in the marketplace and are marked to market on a daily basis. At expiration, the buyer takes delivery of the underlying from the seller or the parties can agree to make a cash settlement.

Special: Futures vs Forwards

April 17, 2007 16:15 IST Share this Ask Users Write a Comment Print this article

What are futures and forward contracts?. Both are contracts to deliver a commodity on a future
date. But they are not the same. Here is all you need to know about futures and forward contracts. Futures and forwards are contracts to deliver a commodity on a future date by a client. Their key differences include: Futures are always traded on an exchange, whereas forwards always trade over-thecounter, or can simply be a signed contract between two parties. Futures are highly standardized, whereas some forwards are unique. The price at which the contract is finally settled is different: Futures are settled at the settlement price fixed on the last trading date of the contract (i.e. at the end). Forwards are settled by the delivery of the commodity at the specified contract price. The credit risk of futures is much lower than that of forwards. Traders are not subject to credit risk because the clearinghouse always takes the other side of the trade. The day's profit or loss on a futures position is marked-to-market in the trader's account. If the mark to market results in a balance that is less than the margin requirement, then the trader is issued a margin call. The risk of a forward contract is that the supplier will be unable to deliver the grade and quantity of the commodity, or the buyer may be unable to pay for it on the delivery day.

In case of physical delivery, the forward contract specifies to whom to make the delivery. The counterparty on a futures contract is chosen randomly by the exchange. In a forward there are no cash flows until delivery, whereas in futures there are margin requirements and a daily mark to market of the traders' accounts. Futures contracts ensure their liquidity by being highly standardized, usually by specifying: The underlying asset or instrument. This could be anything from a barrel of crude oil to a short term interest rate. The type of settlement, either cash settlement or physical settlement. The amount and units of the underlying asset per contract.

This can be the notional amount of bonds, a fixed number of barrels of oil, units of foreign currency, the notional amount of the deposit over which the short term interest rate is traded, etc.
[Edit Comparison Table] Forward Contract Institution al The contracting parties guarantee: Contract size: Expiry date: Futures Contract Hid e All hide

Clearing House

Depending on the transaction and the requirements of the Standardized contracting parties. Depending on the transaction Standardized Quoted and traded on the Exchange

hide

hide hide

Transactio Negotiated directly by the n method: buyer and seller No guranantee of settlement until the date of maturity only Guarantees the forward price, based on : the spot price of the underlying asset is paid Customized to customers Structure: need. Usually no initial payment required. Method of preterminatio n: Opposite contract with same or different counterparty. Counterparty risk remains while terminating with

Both parties must deposit an initial guarantee (margin). The value of the operation is marked to market hide rates with daily settlement of profits and losses. Standardized. Initial margin payment required. Opposite contract on the exchange. hide hide

Forward Contract different counterparty. Risk: High counterparty risk

Futures Contract

Hid e All

Low counterparty risk Government regulated market

hide hide

Market Not regulated regulation:

A forward contract is an A futures contract is a agreement between two standardized contract, traded on a parties to buy or sell an asset futures exchange, to buy or sell a What is it?: hide (which can be of any kind) at a certain underlying instrument at a pre-agreed future point in certain date in the future, at a time. specified price.

Collar
What Does Collar Mean? 1. A protective options strategy that is implemented after a long position in a stock has experienced substantial gains. It is created by purchasing an out of the money put option while simultaneously writing an out of the money call option. Also known as "hedge wrapper". 2. A general restriction on market activities.

Investopedia explains Collar 1. The purchase of an out-of-the money put option is what protects the underlying shares from a large downward move and locks in the profit. The price paid to buy the puts is lowered by amount of premium that is collect by selling the out of the money call. The ultimate goal of this position is that the underlying stock continues to rise until the written strike is reached. 2. An example is a circuit breaker which is meant to prevent extreme losses (or gains) once an index reaches a certain level.

Collars can protect you against massive losses, but they also prevent massive gain

What is prime lending rate(PLR)?

The interest rate that commercial banks charge their best, most credit-worthy customers. Generally a bank's best customers consist of large corporations. The rate is determined by the Federal Reserve's decision to raise or lower prevailing interest rates for short-term borrowing. Though some banks charge their best customers more and some less than the official prime rate, the rate tends to become standard across the banking industry when a major bank moves its prime up or down. The rate is a key interest rate, since loans to less-creditworthy customers are often tied to the prime rate. For example, a Blue Chip company may borrow at a prime rate of 5%, but a less-well-established small business may borrow from the same bank at prime plus 2, or 7%. Many consumer loans, such as home equity, automobile, mortgage, and credit card loans, are tied to the prime rate. Although the major bank prime rate is the definitive "best rate" reference point, many banks, particularly those in outlying regions, have a two-tier system, whereby smaller companies of top credit standing may borrow at an even lower rate.