Exam 4 Flashcards
(23 cards)
Define Derivative Security
an agreement between two parties to exchange a standard quantity of an asset at a predetermined price at a specific date in the future.
Derivatives transfer…
Risk, which results in a positive impact on the economic system
What are derivatives used for
hedging and speculation
Derivative History
- Long and Checkered
- Tulip Bulb Crisis of yore Banned Options
Black Scholes Pricing Model
developed options in 1970
First Wave of Modern Derivatives
were foreign currency futures, developed by IMM which is a division of CME
- fed targets non-borrowed reserves
Second Wave of Modern Derivatives
were interest rate futures, developed by Chicago Board of Trade (CBT) after the Smithsonian Agreement 1971 and 1973
Third Wave of Modern Derivatives
Credit Derivatives in 1990s
Credit Derivatives
Pay the holder if the Credit Risk of an asset Increases
Derivate Gains helped
mask losses on other business lines at Enron ( Major Trader)
Major players in Derivative Market (91%/4)
Banks in OTC Derivatives and Mortgage Backed Securities
Derivatives are now being traded on electronic exchanges.
- Eurex, in chicago with futures, options, t bonds and t bills
- CME Globex
Spot Contract
Is a contract for immediate payment and delivery. 2-3days
Forward Contract
contract for future payment and delivery.
- Negiotable
- Counter Party Risk
- Collateral if needed
- avoids future spot
Credit Forward (buy & sell)
allows the buyer to hedge against an increase of default risk
Bank Buy
Insurance Sell
Clearing Corporation
guarantees payment for both parties in a futures contract so that counterparty default risk is not a concern and principles will not normally know the opposing party in the contract.
Futures
- Standardized in size, maturity and price
- Leverage Investments
Floor broker
Place trade for the Public
Professional Traders
Trade for their own account
Position Traders
based on future expectations
Day Traders
Liquidate positions at end of each day
Hedging
Uses financial futures to reduce risk exposure
Speculation
Uses financial futures to increase profit by gambling movements in interest
