Mortgage market?
Reasons
In USA most of the banks engaged in mortgage market by lending without seeing the client's credit worthiness. But most of the customers fail to repay the long term loan. The banks are allowed to recover such loans by sale of such properties. The total funds have to be reinvested in profitable way. Most of the banks see(BRIC countries)India is one of the countries where they can get better return and also indias inflation is arround 4% and growth rate is around 9%. BRIC-Bracil, Russia, India and China
Derivatives
Prof.L. Augustin Amaladas M.com.,AICWA.,PGDFM.,B.Ed.
RISK /Uncertain???
Case-1 An Indian Garments company has received an order to supply I,00,000 units of shirts from USA. The price of $ 500,000 is receivable after six months. The current exchange rate is Rs.39.76/$. At the current exchange rate, the company would get: 39.76 500,000 = Rs 1,98,80,000. But the company anticipates appreciation of Indian rupee over time. Does the company loose/gain due to appreciation in the Indian Rupee? How does company minimise the risk?
Alternative work is rest
Case 2
You have imported machinery for $ 100,000 on 180 days credit at zero interest. The dollar quotes at Rs 39. Is this deal risk free? This deal is not free of risk because after six months when you pay the loan, if the dollar quotes anything more than Rs39., say Rs 40, you will end up paying more [Rs 1 extra for every $ 1, which is equivalent to Rs 100,000 additional cost]. On the other hand, if the dollar quotes anything less than Rs 39, you will stand to gain The question here is not whether you stand to gain or loose it is the risk you are taking
Case 03
You have surplus cash for investment. You think of investing in Wipro, currently quoting at Rs 3,500, which you believe will rise to Rs 3,950 in six months. Is this deal risk free? This deal is not free of risk because there is no guarantee that Wipros shares would touch Rs 3,950 in six months time. The share prices could rise beyond Rs 3,950 or could also fall below Rs 3,500 giving you no return on investment and you could stand to loose some portion of your investment
Old lady in a seashore!....
Example
You [along with two friends] want to go for the Aero India January 2008 air show, for which tickets are sold out. Through one of your close friends, you obtain a recommendation letter, which will enable you to buy three tickets. The price of a ticket is Rs 1,000. Which is the commodity that you are suppose to buy? In order to buy the________ what are required now? Money/recommendation letter (instrument) or both?
People walking in the seashore scared?...
Financial instruments
The recommendation letter is a derivative instrument. It gives you a right to buy the ticket The underlying asset is the ticket The letter does not constitute ownership of the ticket It is indeed a promise to convey ownership The value of the letter changes with changes in the price of the ticket. It derives its value from the value of the ticket
Children are scared to go near by?...
Meaning
Derivative instruments are called so because they derive their value from whatever the contract is based on A derivative contract is a financial instrument whose payoff structure is derived from the value of the underlying asset These instruments include futures contracts, forward contracts, options contracts, swap agreements, and cap and floor agreements
See the next slide
Advantages
The derivative market helps people meet diverse objectives such as:
Hedging Profit making through price changes Profit making through arbitrage
uses
Price discovery
Most price changes are first reflected in the derivative market. That way derivative market feeds the spot market For instance, if the dollars are going down, it means that the professional investors are expecting dolor price to go down in the future this is a good sign for you to buy in the spot market
Risk transfer
A derivative market is like an insurance company Derivative instruments redistribute the risk amongst market players However, if you want protection against adverse price movements, you must pay a price, ie the premium
Derivative instruments on
Stocks (Equity)
Agri Commodities including grains, coffee beans, pepper,. Precious metals like gold and silver. Crude oil Foreign exchange rate Bonds Short-term debt securities such as T-bills Index Interest rate
TYPES OF DERIVATIVES
Futures
Forwards
Option
Floor cap
Threat is an opportunity
Important terms
LIBOR SWAP OPTION HODER EXERCISE THE CONTRACT CURRENCY SWAPS INTEREST SWAPS PREMIUM AMERICAN OPTION EUROPEAN OPTION BERMUDA OPTION OPTION HOLDER OPTION WRITER CALL OPTION PUT OPTION LONG SHORT
STRIKE PRICE SPOT PRICE EXPIRY OF CONTRACT BASIS RISK COUNTER PARTY RISK
QUESTIONS?
Thank you for all professors & students of II B.Com classes of SJCC . By Prof.Augustin Amaladas