Derivatives and Risk Management. Brock University pMBA. Contents. 1. Introduction. Derivatives and Hedging. Options. Forward and Futures . An Introduction to Derivatives and Risk Management: With Stock-Trak DOWNLOAD PDF Credit Derivatives: Trading, Investing,and Risk Management. DERIVATIVES AND RISK - Download as PDF File .pdf), Text File .txt) or read online. DERIVATIVES AND RISK MANAGEMENT.

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PDF | 40+ minutes read | This study investigated the use of financial derivatives as an instrument for risk management in Nigerian banks. To achieve this. PDF | On Jan 12, , Imran Ramzan and others published Role of Financial Derivatives in Risk Management. As derivative strategies have become more commonplace, risk regulation has tightened. A number Using a derivatives overlay is one way of managing risk exposures arising between assets and liabilities. .. ( pdf).

Also explain the critiques of derivatives with suitable examples. Compare and contrast between forward, futures, options, and swaps.

Write short notes on: b. Swaps and their features c. Options and their types Write a detailed note on uses of financial derivatives. Define the forward contract. Also, discuss the features of the forward contract. Compare and contrast between forwarding contracts and futures contracts with suitable examples. Payoff of derivative which pays the 10m times the excess of the square of the decimal interest rate over 0.

Hedging with forward contract. Income to unhedged exporter. Forward contract payoff. Hedged firm income. Payoff of share and call option strategies. Payoff of downloading one share of site. Payoff of downloading a call option on one share of site. Stulz , Throughout history, the weather has determined the fate of nations, businesses, and individuals. Nations have gone to war to take over lands with a better climate. Individuals have starved because their crops were made worthless by poor weather.

Businesses faltered because the goods they produced were not in demand as a result of unexpected weather developments. Avoiding losses due to inclement weather was the dream of poets and the stuff of science fiction novels - until it became the work of financial engineers, the individuals who devise new financial instruments and strategies to enable firms and individuals to better pursue their financial goals.

Over the last few years, financial products that can be used by individuals and firms to protect themselves against the financial consequences of inclement weather have been developed and marketed.

While there will always be sunny and rainy days, businesses and individuals can now protect themselves against the financial consequences of unexpectedly bad weather through the use of financial instruments.

The introduction of financial instruments that help firms and individuals to deal with weather risks is just one example of the incredible growth in the availability of financial instruments for managing risks.

Never in the course of history have firms and individuals been able to mitigate the financial impact of risks as effectively through the use of financial instruments as they can now. There used to be stocks and bonds and not much else. A manager had to know about the stock market and the bond market to address the problems of his firm.

Over the last thirty years, the financial instruments available to managers have become too numerous to count. Not only can managers now protect their firms against the financial consequences of bad weather, there is hardly a risk that they cannot protect their firm against if they are willing to Chapter 2, page 1 pay the appropriate price or a gamble that they cannot take through financial instruments.

Knowing stocks and bonds is therefore not as useful as it used to be.

Attempting to know all existing financial instruments is no longer feasible. Rather than knowing something about a large number of financial instruments, it has become critical for managers to have tools that enable them to evaluate which financial instruments - existing or to be invented - best suit their objectives. As a result of this evolution, managers and investors are becoming financial engineers.

Beyond stocks and bonds, there is now a vast universe of financial instruments called derivatives.

28C00400 - Derivatives and Risk Management, 11.04.2016-20.05.2016

They are financial instruments whose payoffs are derived from something else, often but not necessarily another financial instrument. It used to be easier to define the world of derivatives.

Firms would finance themselves by issuing debt and equity. Derivatives would then be financial instruments whose payoffs would be derived from debt and equity. Unfortunately, defining the world of derivatives is no longer as simple. Non-financial firms now sell derivatives to finance their activities. There are also derivatives whose value is not derived from the value of financial instruments directly.

Consider a financial instrument of the type discussed in chapter 18 that promises its holder a payment equal to ten million dollars times the excess of the square of the decimal interest rate over 0.

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Chapter 2, page 2 British Bankers Association. Figure 1. Such an instrument does not have a value that depends directly on a primitive asset such as a stock or a bond. Given the expansion of the derivatives markets, it is hard to come up with a concise definition of derivatives that is more precise than the one given in the previous paragraph. A stock option is a derivative because the payoff is explicitly specified as the right to receive the stock in exchange of the exercise price.

With this definition of a derivative, the explicit dependence of payoffs on prices or quantities is key.

It distinguishes derivatives from common stock. The payoffs of a common stock are the dividend payments.

An Introduction to Derivatives and Risk Management: With Stock-Trak Coupon

Dividends depend on all sorts of things, but this dependence is not explicit. There is no formula for a common stock that specifies the size of the dividend at one point in time. The formula cannot depend on subjective quantities or forecasts of prices: The payoff of a derivative has to be such that it can be determined mechanically by anybody who has a copy of the contract. For a financial instrument to be a derivative, its payoffs have to be determined in such a way that all parties to the contract could agree to have them defined by a mathematical equation that could be enforced in the courts because its arguments are observable and verifiable.

Standardization of Contracts For some contracts, the clearinghouses establish maximum and minimum prices at which a contract can trade on a given day. The purpose is to limit large price changes, which can result in large losses for certain parties. The clearinghouse is ultimately responsible for these losses, so it seeks to collect funds before prices move much more and further losses are incurred. In other words, the seller cannot get its hands on the premium until fulfilling its obligation through exercise, or when the contract expires.

Expiration and Exercise Procedures Physical delivery literally requires that the underling be delivered to a specific location or, for securities, transferred electronically to the opposite party.

In case settlement, one party simply pays the other the cash equivalent value. All Rights Reserved.

An Introduction to Derivatives and Risk Management: With Stock-Trak Coupon

May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Over-the-Counter Derivatives Trading Bilateral clearing is clearing between two parties.

They simply impose whatever requirements they wish on each other to minimize the credit risk as they see fit. In multilateral clearing, there is a third party, the clearinghouse sometimes called the central counterparty , which steps in between the two parties. It imposes margin requirements and marks accounts to market daily. With numerous parties engaged in transactions, it can also net across parties. So, if A is owed money from B and owes money to C, the clearinghouse pays A only the net of the two amounts.

This greatly reduces the credit risk.

Market Participants Proprietary trading is the trading that banks and derivatives dealers do for themselves in order to make a profit. Proprietary trading is essentially speculative, though not always purely speculative, as it may involve some hedging.

Bid-Ask Spreads The bid-ask spread is the cost of trading immediately, as opposed to having to wait on a downloader or seller to take the opposite side.

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You download at the bid and sell at the ask, with the latter higher. So, in general, with a constant spread, the price must increase by the amount of the spread.These risks, if managed effectively, can stabilize cash-flows, 6. Summary 4. Other Types of Derivatives A real option is one of many rights a company has in many of its capital investment projects, such as the option to delay launching a project, extend the life of a project, or increase or decrease the scale of a project.

VaR in Freight Markets 7. Future Contracts II A futures contract is an agreement between two parties a downloader and a seller to download or sell something at a future date. For a financial instrument to be a derivative, its payoffs have to be determined in such a way that all parties to the contract could agree to have them defined by a mathematical equation that could be enforced in the courts because its arguments are observable and verifiable.

The important features are there for future contracts: Future contracts are traded on organized future exchanges. Method of pretermination: But it might also be a speculator who wants to make a bet on the weather.

Deficiencies in information, monitoring and control systems, which result in fraud, human error, system failures, management failures etc.