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Chapter 9 - Derivatives: futures, options, and swaps. In this chapter, students will be able to understand: Derivatives transfer risk from one person or firm to another; futures contracts are standardized contracts for the delivery of a specified quantity of a commodity or financial instrument on a prearranged future date, at an agreed-upon price; options give the buyer (option holder) a right and the seller (option writer) an obligation to buy or sell an underlying asset at a predetermined price on or before a fixed future date;. | Chapter Nine 9- Introduction The largely unseen links that OTC derivatives created among global financial institutions made the entire system vulnerable to the weakest of those institutions. As a result of the systemic vulnerabilities posed by OTC derivatives lead to phrases of “too big to fail.” Even before the 2007-2009 financial crisis, stories dealing with the abuse of derivatives abounded. Enron Long-Term Capital Management (LTCM) 9- Introduction Although open to abuse, derivatives can be extremely helpful financial instruments. They can reduce risk, allowing firms and individual to enter into agreements that they could not have otherwise. Derivatives can also be used an insurance against future events. This chapter will provide an introduction to the use and abuse of derivatives. 9- The Basics: Defining Derivatives A derivative is a financial instrument whose value depends on, is derived from, the value of some other financial instrument, call the underlying | Chapter Nine 9- Introduction The largely unseen links that OTC derivatives created among global financial institutions made the entire system vulnerable to the weakest of those institutions. As a result of the systemic vulnerabilities posed by OTC derivatives lead to phrases of “too big to fail.” Even before the 2007-2009 financial crisis, stories dealing with the abuse of derivatives abounded. Enron Long-Term Capital Management (LTCM) 9- Introduction Although open to abuse, derivatives can be extremely helpful financial instruments. They can reduce risk, allowing firms and individual to enter into agreements that they could not have otherwise. Derivatives can also be used an insurance against future events. This chapter will provide an introduction to the use and abuse of derivatives. 9- The Basics: Defining Derivatives A derivative is a financial instrument whose value depends on, is derived from, the value of some other financial instrument, call the underlying asset. Examples of assets include stocks, bonds, wheat, snowfall, and stock market indexes like S&P 500. For example: A contractual agreement between two investors that obligates one to make a payment to the other, depending on the movement of interest rates over the next year. An interest-rate futures contract 9- The Basics: Defining Derivatives Derivatives are different from outright purchases because: Derivatives provide an easy way for investors to profit from price declines. In a derivatives transaction, one person’s loss is always another person’s gain. Buyer and seller are like two people playing poker. 9- The Basics: Defining Derivatives While derivatives can be used to speculate, or gamble on future price movements, they allow investors to manage and reduce risk. Farmers use derivatives regularly to insure themselves against fluctuations in the price of their crops. The purpose of derivatives is to transfer risk from one person or firm to another. 9- .
