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Derivatives Explanation
Why Derivatives?
Types of Derivatives
•Forwards
•Futures
•Options
•Swaps
Forwards Contracts
Terms
A Modest Example
On Friday, you return to the bookstore and take delivery of the book
and pay the $1000.00.
Futures Example
Options
Option Terms
Calls
PUTS
Short a Put. Sell the right to someone else. This will allow them to
sell the asset at a specific price. They feel the price will go down and
you do not. This is a bullish position.
Swaps
Swap Use
•To secure foreign currency for loans when you are a visitor in that
country and it would be too difficult to secure credit or the cost is
prohibitive.
Derivative Securities
Explanation
Freddie Mac & Fanny Mae: Both are derivative instruments used to
pool Home Mortgage loans. This creates a secondary market which
allows banks to sell the loans, therefore reducing their risk. It also
reduces default risk for the holder. These are also known as pass
through instruments.
Sally Mae: Same principal as the previous example except they use
student loans. All of these also help to keep interest rates for the
underlying asset low by keeping default risk down.
Standard Securities
•Stocks
•Bonds
•Cash