final fw mrkt ppt nw

7/31/2019 Final Fw Mrkt Ppt Nw

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Derivatives are the financial instruments which derive their valuefrom the value of the underlying & easily marketable asset.

According to Wikipedia, aderivative is a financial instrument - or moresimply, an agreement between two people or two parties - that has a value

determined by the price of something else (called the underlying).

The underlying asset can be agriculture & other physicalcommodities, currencies, short-term & long-term financialinstruments, price index, or anything that carries a market price.

The price movements of derivative products are related to that ofthe underlying securities.


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Forwards Currency Futures

Currency Swaps Currency Options


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The forward exchange market is a market for contracts regarding

exchange of currencies in the future. Participants in a forwardmarket enter into a contract to exchange currencies, not today, butat a specified date in the future, typically 30, 60, or 90 days fromnow, and at a price (forward exchange rate) that is agreed upontoday. The price of a forward contract is known as the forward

rate. If there is no government intervention on the value of a currency,

the forward market will be governed by demand and supply. The main purpose of forward market is Hedging. . . . . that is the

act of reducing exchange rate risk.

Two Methods involved in Forward market are:Outright Rate: Quoted to commercial customers.Swap Rate: Quoted in the interbank market as a discount

or premium.


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a. ARBITRAGEURS :These players neither hedge nor speculate. Theytry to take advantage of the price differences in the spot andforward markets.

b. HEDGERS :They participate in the forward market with a view toprotect or coveran existing exposure in the spot market.

c. SPECULATORS : A person who makes risky investments,anticipating a major change in the future priceof the asset with aview to make profits from the expected movement in theunderlying element. He makes an investment that involves a risk of

loss but also a chance of profit.

d. TRADERS : One who buys and sells securities for his/her personalaccount , not on behalf of clients.


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A forward contract is an agreement between 2 parties

(counterparties) for the delivery of a physical asset (e.g., oil or gold)at a certain time in the future for a certain predetermined price that isfixed at the inception of the contract.

Forward contracts can be customized to accommodate anycommodity, in any quantity, for delivery at any point in the future, atany place.

For eg. : On 10th nov., Ram enters into an agreementto buy 100 kgsof wheat on 1st May at Rs.10000 from Shyam, a farmer.

It is a case of forward contract where Ram has to pay Rs.10000 on 1st

May to Shyam & Shyam has to supply 100 kgs of wheat. Ram hastaken a long position assuming the price of the wheat will rise in thefuture six months.


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There are 2 parties to every forwards contract - the seller of the

contract, who agrees to deliver the asset at the specified time in thefuture, & the buyer of the contract, who agrees to pay a fixed priceand take delivery of the asset.

Price changes in the asset after the forwards contract agreement ismade, provides gain to one party at the expense of the other.

Forwards contract may be used by a buyer or seller to hedge otherpositions in the same asset.

If the price of the underlying asset increases in the market after theagreement is made, the buyer gains at the expense of the seller. If theprice of the asset drops, the seller gains at the expense of the buyer.


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Depending on the underlying asset, the most

common types of forward contracts are: Currency Forwards

Interest Rate Forwards, and

Commodity Forwards


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It is a customised contract between 2 partiesfor purchase or sale of currency (foreignexchange) at a specified price to be delivered

at a specified date in the future.


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It is customised & can be used by any person or institution.

Only 2 parties are involved in contract for purchase or sale ofcurrencies.

Agreement to buy or sell an asset at certain time in the future(i.e., delivery date can be any date that is mutually convenientto both the parties to the contract) for a predetermined price.

It is an Over-the-counter product that do not trade on any

organized exchange. Size can be customized .


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Not marked-to-market daily No initial cost/investment (i.e., it costs nothing to buy or

sell forward). No initial margins are required to be kept

One-to-one negotiations leads to tremendous flexibility. Forward Exchange rate can be at par, premium or discount

with reference to spot rate.

Adv. :The parties/company is protected against exchange

rate fluctuations.


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Difficult to search counter party :

Finding counterparties who want to take exactly theopposite positionis not an easy task.One of the parties to the transaction might want to trade a

different amount, or have a different settlement date

Exchange rate fluctuations : Once a company has covered atransaction with a forward exchange contract, it cannot take

advantage of favourable exchange rate movements.

High Penalty cost : chance of suffering a large loss.


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Lesser Liquidity/Liquidity risk: due to absence ofexchange market or institutional framework to conduct thetrading, aparty in a forward contract may find it difficult toexit the position.

Alternatives:-

If counterparty agrees, cancel the forward for a fee.Assign the contract to another party. This requires some

compensation.

If an exact opposite position can be taken, offset the

obligation and suffer only the price differential Default risk : No performance guarantee-due to higher

counter party risk.


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Forward Premium/Discount:

= FwR-SR x 12 x 100SR n

where F = The forward rate of exchange

SR = The spot rate of exchange

n = The number of months in theforward contract


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Relationship between the

forward price and theexpected spot price?


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FFwR = e (SR)

e (spot rate)

t


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F

FwR > e (SR)

e (spot rate)

t


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FFwR < e (SR)

e (spot rate)

t


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Type of ContractCustomized acc. To the

suitability of the parties

Standardized acc. to the

specifications of the

futures exchange

MaturityContracting parties may choose

any maturity desired

There are only a few

maturity dates

RegulationsSelf-regulation prevails, subject

to govt. restrictions

Exchanges maintain

detailed regulations for

their members

Counter party riskExists for parties/partners Exists for

exchange/clearing house

Mark to market No mark to market Applicable

MarginsInitial amount not required to be

kept parties

Initial amount is required

to be kept parties

Negotiations

One to one negotiation leads to

flexibility

No negotiations


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Buy forward to hedge against a priceincrease.

Sell forward to hedge against a pricedecrease.


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final fw mrkt ppt nw

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