Different types of Derivative

Instrument

Forward
Futures
Options
Swaps

Fall 2012, FDRM

What is Forward?
Simply forward is an agreement between two
parties to buy or sell an assets at a certain
future time for a certain price agreed today
It is not standardized
The party agreeing to buy underlying assets
in the future assumes long position and the
party agreeing to sell the assets in the future
assumes a short position. The price agreed
upon is called the delivery price.
Fall 2012, FDRM

What is future?
Is agreement between two parties
to buy or sell an assets to a
certain time in a future, at a
prespecified price
Are traded on the organized
exchange
It is standardized; e.g. GOl, OCT.
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Fall 2012, FDRM

What is an Option?
Option is the right to buy or sell
the underlying assets or
commodity at the some point in
the future for a predetermined
price.
A call option gives the buyer the
right to buy the underlying asset;
a put option gives the buyer of
the option the right to sell
Fall 2012, FDRM

What is swaps?
A swap is a derivative in which two
counterparties exchange certain
benefits of one party financial
instrument for those of the other
party financial instruments.
Specifically, the two counterparties
agree to exchange one stream of
cash flows against other stream.
These streams are called the legs of
swap. The swap agreement defines
the dates when the cash flows are to
Fall 2012, FDRM

cond.
Usually at the time when the contract is
initiated at least one of these series of
cash flows is determined by a random or
uncertain variable such as interest rate,
foreign exchange rate, equity price or
commodity price.
Suppose A company issued a Fixed 12%
annual coupon bond with 10 years
maturity. Similarly, Company B also issued
10 year bond with floating interest rate.
Then, these two companies can swap their
Fall 2012, FDRM
6
liability of interest payments.

Some Concepts in Financial

Derivative Markets

Risk preference
Short selling
Repurchase agreement
Calculated vs theoretical value