ac103 lecture 10.pdf
TRANSCRIPT
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DerivativeSecuities
Financingabusiness:Summary
Raisingmoneyisdifficult
financed
Ingeneral,
ahigh
risk
form
of
finance
has
to
offer
the
prospectofhighreturns
Raisingsmallscaleinitialfinancingisverydifficult
Aprivateinvestorisinterestedinreturnoninvestmentandtherisktaken.
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Financingabusiness:
Summary
Governmentsareinterestedin
Becauseofthis,governmentsmayfindit
considersittobetoorisky.
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ShouldGovernmentsHelp?
directgrantaid
subsidisedemployees
trainingschemes
taxbreaksforinvestors
backtoworkschemes
loan uarantees
Askthequestion:Ifaprivateinvestorwontfundit,isitworth
doing?
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ShouldGovernments
Help?
Cofunding partfundedbyEnterpriseIreland,butprivate
investors needed as well to kee com anies close to market
realities
Financingisamarketingproblem:thecompanypackagestherighttothecashflowgeneratedbyitsassetsindifferentways
inordertoattractfinancefrombanks,bondholders,equity
holdersandgovernments.
BottomLine:
DoubleBottomLine:
TripleBottomLine:
IntroductiontoFinance1:AC103 5
DerivativeSecurities
Asecurityisanyfinancialinstrument,beite torequ tyorsomecom nat ono t e
two
Aderivative
security
derives
its
value
from
an
underlyingsecurity(orothermeasurable
item
Itisawayoftakingbets,eitherasapuregamble,ortooffsetsomeunderlyingposition
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Hedging
Takingapositionthatpaysoutifsomethinggoesaga ns you
HedgingRisk
Firmsfacemanyriskswhichmaybereduced
Theriskoflossduetofireornaturaldisaster
maybe
hedged
by
taking
out
Insurance
FinancialRisk(exchangeratechanges,interestratechanges)maybehedgedusing
Derivativecontracts
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FinancialDerivative
Securities
Twotypes:
1.Tiesyoutoaparticularaction,nomatter
whatgoesonintheunderlyingmarket
2.Givesyouachoice,whichyoumake
epen ngon
eun e y ng
ma e
(contingentclaim)
FinancialDerivativeSecurities
Twowaysoftrading:
Overthecounter(OTC)
Viaaspecialisedexchange
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FinancialDerivative
Securities
Example:
Easons importsmagazinesforUK,fordistributioninIreland
Knows(roughly)howmanymagazines,andthesterlingcostofthemagazines
Canpurchasecurrencyforward,buyacurrencyfutureorpurchaseacurrencyoption
ForwardContracts
Aforwardcontractisanagreementtobuyorse anassetatacerta nt me nt e uture ora
certainprice
Thereis
no
daily
settlement
. Thecontractisanoverthecounter(OTC)
agreementbetween2parties
Nomoneychangeshandswhenfirstnegotiated&thecontractissettledatmaturity
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ForwardContracts
Aforwardcontractisanagreementtobuyorsellanasset at a certain time in the future for a certain rice
Thecontractisanoverthecounter(OTC)agreementbetween2companies
Nomoneychangeshandswhenfirstnegotiated&thecontractissettledatmaturity
Toda s sterlin s ot rate mi ht be 0.8562 er Euro
andthe
forward
rate
0.8432
for
asix
month
forward
contract
Tiesdownthevalueofthesterlingneeded
ForwardContracts
Aforwardcontractisanagreementtobuyorsellan
price
Youmay
end
up
buy
sterling
at
aworst
rate
than
ifyou
hadnotengagedinthecontract dependsonwhathappenstotheunderlyingmarket
ur ng ecurrencycr s so eau umn , asonswerereportedlybuyingsterlingataveryexpensiverate
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Terminology
Thepartythathasagreedtobuyhasaong pos t on
Thepartythathasagreedtosellhasashort position
FuturesContracts
Afuturescontractisanagreementtobuyorsellanassetatacertaintimeinthe
futureforacertainprice
Itis
astandardised contract
and
traded
on
anexchange
tobuyorselltheassetimmediately
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Examplesof
Futures
Contracts
Agreementto:
Margins
Forwardshavenoupfrontpayments,futureshavemargincalls
Amarginis(usually)cashdepositedbyaninvestorwith
a
broker Marginsminimizethepossibilityofdefaultloss
Theyaresettleddaily markedtomarket
offsettingtrade
Mostcontractsareclosedoutbeforematurity
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Forwardvs
Futures
Private contract between 2 parties Exchange traded
Non-standard contract Standard contract
Usually 1 specified delivery date Range of delivery dates
FORWARDS FUTURES
Settled at maturity Settled daily
Delivery or final cashsettlement usually occurs
Contract usually closed outprior to maturity
HedgingwithFuturesExample Youareahogfarmer.ItisApril
andyouintendtosell300,000lbsof
ogmea n c o er. ou ear a e
pricewilldropinthefuture.The
currentspotpriceforhogsis$0.22per
poundandthe6monthfuturespriceis
$0.20.Eachcontractisfor30,000lbs.
Thus to hed e our rice risk ou short
10HogFutures. Ifthepricedropsto
$0.17centsperpoundwhatisthe
effectofthehedge?
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Hedgingwith
Futures
Youcloseoutyourpositionimmediatelybefore
ProfitonFutures:
Options
AnOPTIONisanothertypeofderivative
Anoptiongivestheholdertheright tobuyor
sellat
acertain
price
Theexpirationdate(maturity)isthedatethecontractfinishes
Thestrikepriceisthepricespecifiedinthecontractatwhichtrademaytakeplace
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OptionTerminology
CallOption
PutOption
OptionTerminology
Foraspecifiedstrikeprice,X;
ASHORTCALL givessomebodyelsethe
rightto
buy
from
you.
ALONGPUT givesyoutherighttosell
toselltoyou
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CurrencyOptions
Easons mightpurchaseacurrencyoptionw c pu saupper m on e urocos o
thesterlingrequired
Ifthecurrencycanbeboughtcheaperinthespotmarket,do tearupyouroption,looking
atitasunneededinsurance
AmericanvsEuropeanOptions
Thesetermsdonotrefertothelocationof
AnAmericanoptioncanbeexercisedatany
timeduring
its
life
AEuropeanoptioncanbeexercisedonlyatmaturity
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OptionPayoff
Thepayoffofanoptionatexpirationisafunction.
Example Stockoptionvaluesgivenaexercisepriceof$40
10080604020$0PriceStock
PayoffPut
PayoffCall
LongCallOptionPayoff
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LongPut
Option
Payoff
ShortCallOptionPayoff
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ShortPut
Option
Payoff
Derivatives:Summary
Waysoftakingbetsonpricemovements
Maybeusedtohedgeortospeculate
Cangivegoodprotection
Cangiverisetolargeloses
WidevarietyinderivativesecuritiesFinancialEngineering