DERIVATIVES

FATIMA RAZA (1917/FMS/BBA/S07)KAUSAR WAHAB (1924/FMS/BBA/S07)NITASHA MUBASHAR (1934/FMS/BBA/S07)

KAUSAR WAHAB

DERIVATIVES

“A derivative is a financial instrument that is derived from some other asset, index, event, value or condition (known as the underlying

asset)”

TYPES OF DERIVATIVES

Four main types of derivatives:

1. Forwards2. Futures3. Options

4. Swaps

TYPES OF DERIVATIVES

1. FORWARDS

“ A forward contract is an agreement between a corporation and a commercial bank to exchange a specified amount of a

currency at a specified exchange rate (called the forward rate) on a specified date in

future”

1.FORWARDS

FORMULA FOR FORWARDS

F=S (1+p)

WhereS=Spot Ratep=premium

FORMULA FOR FORWARDS

2. FUTURES

“A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument

at a certain date in the future, at a specified price”

2.FUTURES

FORWARDS Vs FUTURES

Tailored to individuals need

Expiry date and contract size depends on the transaction

Negotiated directly by the buyer and seller

Standardized Standardized contract

size n expiry date Quoted and traded on

the Exchange

FORWARDS FUTURES

FATIMA RAZA

Currency Options Market

• Currency options provide the right to purchase or sell currencies at specified prices. Options can be purchased or sold through brokers for a commission.

TYPES OF OPTIONS

• An option that can be exercised at any time before and on the expiration date.

American Option

• An option that can be exercised only on the expiration date.

European Option

Currency

options are classified as

Currency put

options

Currency call

options

Currency Call Options

A currency call option grants the right to buy a specific currency at a designated price within a specific period of time. The price at which the owner is allowed to buy that currency is known as the exercise price or strike price.

Currency Call Options

If the spot rate of the currency rises above the strike price, owners of call options can “exercise” their options by

purchasing the currency at the strike price, which will be

cheaper than the prevailing spot rate. S>X

The owner can choose to let the option expire on the expiration date without ever exercising it.

A currency call option is said to be in the money when the

present exchange rate exceeds the strike price S>X

At the money when the present

exchange rate equals the strike price

S=X

Out of the money when the present

exchange rate is less than the strike price S<X

Buyer of call option

• + Selling price (S t+1)• - Purchase price (E)• - Premium paid for option (P)

Seller of call option

• + Selling price (E) • - Purchase price (S t+1)• + Premium paid for option (P)

Currency Put Options

The owner of a currency put option receives the right to sell a currency at a specified price (the strike price) within a specified period of time.

A currency put option is said to be in the money when the

present exchange rate is less than the

strike price S<X

At the money when the present

exchange rate equals the strike price

S=X

Out of the money when the present

exchange rate exceeds the strike price

S>X

+ Selling price (E)

- Purchase price (S t+1)

- Premium paid for option (P)

Buyer of put option

Seller of

put option

+ Selling price (S

t+1)

- Purchase price (E)

+ Premium paid for

option (P)

NITASHA MUBASHIR

“A Swap is a contract between two parties to deliver one sum of

money against another sum of money at periodic intervals”

4.SWAPS

TYPES OF SWAPS

Interest Rate Swap

Currency Swap

Credit Risk Swap

Commodity Swap

Equity Swap

“An exchange of fixed interest payment for floating interest

payments by two counterparties is called interest rate swap”

INTEREST RATE SWAP

TERMINOLOGIES USED

Swap Buyer (Long)

Swap Seller (Short)

Notional Principal

Swap Tenor

Floating and Fixed Rate

WHY DO FIs SWAP???

EXPLAINATION OF INTEREST RATE SWAP

POSITION OF COMPANIES

FLOATING RATE MARKET

FIXED RATE MARKET

ABC COMPANY

Bonds issued Loans issued to public

XYZ COMPANY

Loans issued to public

Bonds issued

Fixed Rate

Receiver (Return)

Floating Rate

Payment (Cost)

Bond Issued

Loan to

Public

POSITION OF COMPANY ABC

POSITION OF COMPANIESFLOATING RATE MARKET

FIXED RATE MARKET

ABC COMPANY

Bonds issued Loans issued to public

PUBLICPUBLIC PUBLICPUBLIC

ABC COMPANYABC COMPANY

POSITION OF COMPANY XYZ

Bond Issued

Loan to

Public

Fixed Rate

Payment (Cost)

Floating Rate

Receiver

(Return)

POSITION OF COMPANIESFLOATING RATE MARKET

FIXED RATE MARKET

XYZ COMPANY

Loans issued to public

Bonds issued

XYZ COMPANYXYZ COMPANY

PUBLICPUBLIC PUBLICPUBLIC

XYZ COMPANY

XYZ COMPANY

PUBLICPUBLIC

ABC COMPANY

ABC COMPANY

PUBLICPUBLIC

Swap contract

Swap contract

In swap contract: (buyer) In swap contract: (seller) Floating rate receiver Floating rate payment Fixed rate payment Fixed rate receiver

Fixed Floating Floating Fixed Rate Rate Rate RateReceiver Payment Receiver Payment

THE

END