Securities a contract that can be assigned a value and traded. instruments representing ownership (stocks), a debt agreement (bonds) or the rights to ownership (derivatives). Source: Investopedia

DERIVATIVES

What are derivatives? Financial instruments whose price depends on the movement of another price The value of the contract is derived from another asset ↓ the underlying asset:commodities, currencies, securities Futures & forwards, options, swaps

COMMODITIES Wheat Coffee Palm oil Nickel Sugar Maize Milk Bauxite Iron ore Wool Grain Rubber Wine Copper Beef Tea Zinc Gold Lead Oil Phosphates Tin Timber Silver

Commodities can be traded... ...for immediate delivery at their current prices on spot (cash) markets ... for future deliveries at prices fixed at the time of the deal on futures markets

Futures: The Case of a Silversmith Fill in the missing words: retail, volatile, at, hedge, contract, set, goes up, risk, increase, futures, declined A silversmith must secure a certain amount of silver in six months time for earrings and bracelets that have already been advertised in an upcoming catalog with specific prices. But what if the price of silver 1………….over the next six months? Because the prices of the earrings and bracelets are already 2………., the extra cost of the silver can't be passed on to the 3……….. buyer, meaning it would be passed on to the silversmith. The silversmith needs to 4………….., or minimize 5………….. against a possible price 6………….. in silver. How? Source: http://www.investopedia.com/university/futures/futures3.asp

Futures: The Case of a Silversmith Fill in the missing words: retail, volatile, at, hedge, contract, set, goes up, risk, increase, futures, declined The silversmith would enter the 7……………….. market and purchase a silver contract for settlement in six months time 8……………a price of $5 per ounce. At the end of the six months, the price of silver in the cash market is actually $6 per ounce, so the silversmith benefits from the futures 9…………… and escapes the higher price. Had the price of silver 10…………….in the cash market, the silversmith would, in the end, have been better off without the futures contract. At the same time, however, because the silver market is very 11………………., the silver maker was still sheltering himself from risk by entering into the 12…………………contract. Source: http://www.investopedia.com/university/futures/futures3.asp

Futures: The Case of a Silversmith What type of derivatives is described in this example? What is the underlying asset involved? Why does the silversmith buy the contract? What is derived from what in this example?

Options Study the two theoretical situations illustrating the buying of an option in an everyday situation: http://www.investopedia.com/walkthrough/corporate-finance/5/risk-management/options.aspx Answer the questions: What value is the derived value in this example? What options did the buyer of the option have? What was the underlying asset involved? What can affect the price of an option in this case? Who takes most risk? Is this option a call option or a put option?

Options: Buying a House http://www. investopedia 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.

Options: Buying a House Source: www.investopedia.com Two theoretical situations might arise: 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).

Options: Buying a House Source: www.investopedia.com 2. While touring the house, you discover not only that the walls are full of asbestos, but also that the ghost of Henry VII haunts the master bedroom; furthermore, a family of super-intelligent 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.

Swaps What can be swapped? Currency rates, interest rates, commodities, risks of defaults (!), …

Can you find synonyms and opposites in MK:p.92? floating rate put option hedging agreed-upon price option to sell pre-determined price swap call option speculation exchange option to buy fixed rate pre-arranged price strike price

Optional reading

MK:pp.89-90 What was the market like at the time? What did investors require? What normally happens with ROI if stock markets fall? What was hedge funds’ investment strategy? How did this affect other financial institutions?

Spread – betting (MK: p.93) Explain the reason for calling such transactions “spread-betting”? Two reasons for spread-betting? Risky only?