introduction to financial derivatives

Introduction to Financial Derivatives

Lecture #1

Jinho Bae

March 6, 2008

Ch.1 Introduction to futures

Types of transactions

• Spot

• Forward

• Futures

Types of transactions

1. Spot transaction

A transaction where the seller delivers a good to the buyer and the buyer pays the price immediately.

e.g) Purchase of a fridge at Himart

1M won

Question) If credit card rather than cash is used to pay, will it be a spot transaction?

Couple Hi-Mart

Hyundai card

Fridge (now)

1M won (now) 1M won(1 month later)

Answer)

2. Forward

An agreement to sell or buy an asset (good) at a certain time in the future for a certain price

At the time of agreement, both parties determine the time and the price.

No delivery or payment is made at the time of agreement.

Delivery and payment are made at the agreed-upon future date.

Also called forward contract.

e.g.) An agreement to buy 100 heads of white cabbage in December for 1,000 won per head

0.1M won

Today

December

Contract

Some characteristics of a forward contract

Buyer and seller must seek each other (sometimes time-consuming)

Various terms and conditions can be put in the contract

- Quantity

- Price

- Delivery date

No guarantee of fulfillment of the contract

3. Futures An agreement to sell or buy an asset at a

certain time in the future for a certain price

Some characteristics of futures contract

The exchange is the other side of futures contract

• Case of buying

exchange buyer

• Case of selling

exchange seller

Fulfillment of the contract is guaranteed

Fulfillment of the contract is guaranteed

Cf) Two parties of forward transaction

buyer seller

Standardized terms and conditions

• E.g.: Gold futures– Only Gold bar (99.99% pure) is traded– Contract size: 1Kg– Tick Size & Value : 10 won/g, representing a

value of KRW 10,000

Main differences between futures and forward

Futures Forward

Traded on an exchange

Private contract between two parties

Standardized Not standardized

No credit risk Some credit risk

Animation about futures

• Korea Exchange: http://fm.krx.co.kr

KRX info center/Cartoon Plaza

KRX info center/Flash Plaza

Gold bar