Introduction and Overview of Derivatives
Autor: 力豪 温 • December 19, 2018 • Coursework • 548 Words (3 Pages) • 819 Views
Tutorial 1: Introduction and Overview of Derivatives
Question 1
Briefly explain the derivative instrument, and how is it different from stocks and bonds.
-A derivative instrument is a financial asset that derives its value from its underlying asset.
-The underlying asset could be a commodity or another financial asset.
-Unlike stocks and bonds that represent a direct claim, derivatives can be thought of as claim on a claim. WHY?
Question 2
Discuss the key categories of players in derivatives markets, and briefly describe the objective of each category of players.
-Hedgers: To manage risk
-Arbitrageurs: To take advantage of mispricing
-Speculators: To take positions based on their expectation in order to gain the price differences
Question 3
Explain how might the absence of speculators/speculation hurt hedgers.
-Reduced liquidity, then reduced trading volume and hence higher transaction cost, as a result, hedgers have to pay more.
- Lack of counterparties for hedgers to pass on their risk.
DO WE NEED THEM IN MARKET?
Question 4
Using appropriate example, differentiate between commodity and financial derivatives.
Commodity derivatives | Financial derivatives |
Commodity derivatives have tangible underlying assets like agricultural produce and metals. | Financial derivatives have financial instruments as underlying assets. |
All commodity derivatives have actual and physical settlement of underlying commodity at maturity. FCPO- long – deliver the oil to ur house 😊 | Mostly done in cash settlement as it involves not the exchange of actual underlying asset but the monetary equivalent of the asset. |
E.g: Agricultural commodities, metal and energy | E.g: Foreign currencies, equity, and bond futures |
Question 5
Explain the benefit(s) do arbitrageurs and speculators bring to derivatives markets.
Arbitrageurs
-Promote market efficiency as arbitrageurs, by mean of their activities, ensures that prices in different markets (Spot, Futures, Options) do not diverge from each other.
-Enhance price discovery, by mean of their activities, seeking price divergence between markets in different countries to "internationalizes" the product prices.
-Helps to reduce the distortionary effects of government regulation/intervention.
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