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Lecture Financial institutions, markets, and money (9th Edition): Chapter 11 - Kidwell, Blackwell, Whidbee, Peterson

Chapter 11 - Derivatives markets. This chapter describes the nature of the most important markets for financial derivatives. It starts with forward and futures markets, then discusses the swaps and options markets. It discusses how markets work, what financial instruments are traded in each, who the major participants are, and how the markets are regulated. | Power Point Slides for: Financial Institutions, Markets, and Money, 9th Edition Authors: Kidwell, Blackwell, Whidbee & Peterson Prepared by: Babu G. Baradwaj, Towson University and Lanny R. Martindale, Texas A&M University CHAPTER 11 DERIVATIVES MARKETS The Nature of Derivative Securities Derivative securities are used to minimize or eliminate an investor’s or a firm’s exposure to various types of risk that they may be exposed to. Derivatives are financial securities which are based upon or derived from existing securities. Risk to an investor or a firm can be caused by interest rate changes or foreign exchange rate changes, commodity prices or stock prices The purpose is to eliminate the price risk inherent in transactions that call for future delivery of money, a security, or a commodity. Spot versus Forward Market Trading for immediate or very-near-term delivery is called the spot market. Trading for future delivery - forward market. Forward Markets Buying/selling of a specified amount, price, and future delivery date of foreign currency. Direct relationship between buyer and seller. Foreign exchange dealers earn revenues on the spread between buying and selling. Seller delivers at the specified date called the settlement date. Buyer of the forward contract has the long position; seller of the forward contract has the short position. Banks and foreign exchange dealers are the primary counter-parties to most transactions in the forward market. Futures Markets Buying/selling of standardized contracts specifying the amount, price, and future delivery date of a currency, security, or commodity. Buyers/sellers deal with the futures exchange, not with each other. A specific trade (buy/sell) involves a hedger and a speculator. Delivery seldom made - buyer/seller offsets previous position before maturity. Futures contracts expire on specific dates. Margin requirements exist – varies by contract type. Margin Requirements Initial margin - small . | Power Point Slides for: Financial Institutions, Markets, and Money, 9th Edition Authors: Kidwell, Blackwell, Whidbee & Peterson Prepared by: Babu G. Baradwaj, Towson University and Lanny R. Martindale, Texas A&M University CHAPTER 11 DERIVATIVES MARKETS The Nature of Derivative Securities Derivative securities are used to minimize or eliminate an investor’s or a firm’s exposure to various types of risk that they may be exposed to. Derivatives are financial securities which are based upon or derived from existing securities. Risk to an investor or a firm can be caused by interest rate changes or foreign exchange rate changes, commodity prices or stock prices The purpose is to eliminate the price risk inherent in transactions that call for future delivery of money, a security, or a commodity. Spot versus Forward Market Trading for immediate or very-near-term delivery is called the spot market. Trading for future delivery - forward market. Forward Markets Buying/selling of a