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Derivatives?
Prepared By
Robb Davis
Robert McDaniel
David Bolles
Mike McLatcher
Calvin Grogan
Amanda Hodges
DERIVATIVES
20,000
Billions of $
Amount in
15,000
10,000
5,000
0
Bonds Cash Stocks
Types
Types of Derivatives
• Forwards
• Futures
• Options
• Swaps
Forwards
Forwards Contracts
7,000
6,000
5,000
Billions of $
Amount in
4,000
3,000
2,000
1,000
0
Interest-Rate Stock-Index Currency
Futures Futures Futures
Types
Forwards “OTC”
Over-The-Counter Derivatives "Forwards"
Interest-Rate
Contracts
28%
Currency Contracts
72%
A Modest Example
An agreement on Monday to buy a book,
(Fin 374c) from a bookstore on Friday for
$1000.00.
On Friday, you return to the bookstore and
take delivery of the book and pay the
$1000.00.
The contract is actually the agreement.
Futures
Futures
Similar to forwards in length of time.
However, profits and losses are
recognized at the close of business
daily, “Mark-to-market.” Transactions
go through a clearinghouse to reduce
default risk. 90% of all futures
contracts are delivered to someone
other than the original buyer.
Futures Example
On Monday we enter into a futures contract to buy
our book on Friday. We are required to place a
deposit for the book of 50% ($500.00). We are told
that if the book appreciates in value we may be
required to increase the deposit. If the book
depreciates in value, we may take back some of the
money. Wednesday the book goes to $1500.00. We
must deposit another $250.00. On Thursday the book
drops to $750.00. We can collect $375.00. On Friday
the book value is $800.00, therefore we owe $425.00
on the remaining balance.
Options
Options
Options come in many flavors. To name a
few: collar, cylinder, fence, mini-max,
zero-cost tunnel and straddle. These are all
newer forms of options. The most
common options discussed are put and
call.
An OPTION is the right, not the obligation
to buy or sell an underlying instrument.
Option Terms
• Put: the right to sell @ a certain price
• Call: the right to buy @ a certain price
• Long: to purchase the option
• Short: to sell or write the option
• Bullish: feel the value will increase
• Bearish: feel the value will decrease
• Strike/Exercise Price: Price the option
can be bought or sold.
Option Market
Exchange Traded Derivatives "Options"
Stock-Index Options
Types
Currency Options
Interest-Rate Options
In Billions of $
Options Continued
Over-The-Counter Derivitaves "Options"
OTC Currency
Options
29%
OTC Interest-Rate
Options
71%
Calls
Long a call. Person buys the right (a contract) to
buy
an asset at a cretin price. They feel that the price
in the future will exceed the strike price. This is a
bullish position.
Currency Sw aps
12%
Interest-Rate Sw aps
88%
Swap Use
• To smooth out interest rate payments
in a cyclic environment.
• To secure and level out future interest
payments.
• To secure foreign currency for loans
when you are a visitor in that country
and it would be too difficult to secure
credit or the cost is prohibitive.
Derivative Securities
• Mortgage Backed Securities: Fanny
Mae, Freddie Mac
• Structured Notes: Sally Mae
Derivative Securities
Derivitave Securities
800
600
400
200
0
Mortgage Structured
Derivatives Notes
Explanation
Freddie Mac & Fanny Mae: Both are
derivative instruments used to pool Home
Mortgage loans. This creates a secondary
market which allows banks to sell the loans,
therefore reducing their risk. It also reduces
default risk for the holder. These are also
known as pass through instruments.
Cont’d Explanation
800
600
400
200
0
Mortgage Structured
Derivatives Notes
Standard Securities
• Stocks
• Bonds
• Cash
Standard Securities
Traditional Securities
20,000
Billions of $
Amount in
15,000
10,000
5,000
0
Bonds Cash Stocks
Types
Total Market
The standard market is what most people
think of when they think of the market. The
truth is that derivatives are the fastest growing
sector of the market. In fact, they are the
largest section of the market. We did not
consider mutual funds in this presentation.
There are more mutual funds in the market
than there are stocks. Again, the next graph
does not account for mutual funds.
Total Market
Total Market: Traditional & Derivative
Total Derivatives
43%
Total Traditional
57%
Any Questions?
Seriously,
Any Questions?