1. Copyright © 2002 Pearson Education, Inc. Slide 9-1

2. Copyright © 2002 Pearson Education, Inc. Slide 9-2 Chapter 9 Derivative Securities and Derivative Markets

3. Copyright © 2002 Pearson Education, Inc. Forward Transactions and Derivatives Derivative securities derive their economic value from underlying assets. Spot markets: settlement is immediate. Forward transactions: settlement is in the future. Although forward transactions provide risk sharing, they have liquidity and information problems.

4. Copyright © 2002 Pearson Education, Inc. Futures A futures contract specifies delivery at a future date at a current price. The buyer assumes the long position. The seller assumes the short position. Futures price: set in the futures market. Spot price: price on the date of delivery. Futures contracts can reduce risk through hedging.

5. Copyright © 2002 Pearson Education, Inc. Slide 9-5 Table 9.1 Reducing Risk with Futures

6. Copyright © 2002 Pearson Education, Inc. Options Option is the right to buy or sell an asset at a predetermined price by a predetermined time. Call option: the right to buy an asset. Put option: the right to sell an asset. Strike price: the price at which the asset is bought or sold. Option premium: the fee for option.

7. Copyright © 2002 Pearson Education, Inc. Determinants of Option Premium Higher volatility in the asset price increases the option premium. Closer to expiration date, the option premium approaches its intrinsic value. The further away from expiration, the higher is the option premium. A higher interest rate reduces the option premium.

8. Copyright © 2002 Pearson Education, Inc. Benefits of Derivative Markets Derivative markets provide risk sharing, liquidity, and information. Derivative instruments are liquid because they are standardized. Anonymous trading reduces information costs.

9. Copyright © 2002 Pearson Education, Inc. Slide 9-9 Figure 9.1 Derivative Markets Add Value