TAILIEUCHUNG - Lecture Financial derivatives - Lecture 5: Common financial derivatives

The contents of this chapter include all of the following: Common financial derivatives, why have derivatives? the risks, leveraging, trading of derivatives, derivatives on the internet, an apologia for derivatives, the dark side of derivatives. | LECTURE 05 Common Financial Derivatives Common Financial Derivatives Why Have Derivatives? The Risks Leveraging Trading of Derivatives Derivatives on the Internet An Apologia for Derivatives The Dark Side of Derivatives Repayment of Financial Derivatives In creating a financial derivative, the means for, basis of, and rate of payment are specified. Payment may be in currency, securities, a physical entity such as gold or silver, an agricultural product such as wheat or pork, a transitory commodity such as communication bandwidth or energy. The amount of payment may be tied to movement of interest rates, stock indexes, or foreign currency. Financial derivatives also may involve leveraging, with significant percentages of the money involved being borrowed. Leveraging thus acts to multiply (favorably or unfavorably) impacts on total payment obligations of the parties to the derivative instrument. Common Financial Derivatives Options Forward Contracts Futures Stripped Mortgage-Backed Securities Structured Notes Swaps Rights of Use Combined Hedge Funds A Brief Guide to Financial Derivatives Stripped Mortgage-Backed Securities Stripped Mortgage-Backed Securities, called "SMBS," represent interests in a pool of mortgages, called "Tranches", the cash flow of which has been separated into interest and principal components. Interest only securities, called "IOs", receive the interest portion of the mortgage payment and generally increase in value as interest rates rise and decrease in value as interest rates fall. Principal only securities, called "POs", receive the principal portion of the mortgage payment and respond inversely to interest rate movement. As interest rates go up, the value of the PO would tend to fall, as the PO becomes less attractive compared with other investment opportunities in the marketplace. Structured Notes Structured Notes are debt instruments where the principal and/or the .

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