CHAPTER 9: DERIVATIVES

CHAPTER 9: DERIVATIVES

1. Hedging: Act of buying and selling commidity to protect again risk of future price fluctuations.

2. Hedging Tools

   • Options
     • Call options give the holder right but not obligation to buy while put right to sell.
     • def: agreement between buyer n seller to give the holder of the contract to buy/sell future contract or other asset @specified price b4 expiry.
   • Futures
     • At delivery date, seller can;
       • Purchase future contract for same security with the same delivery date. ex: foreign currencies
       • buy security on the spot market n deliver
       • deliver the security
     • The seller agrees to deliver specific security@fixed price@specific time in future
   • Swaps
     • Borrowers selalu nego swaps bila dah reach agreement on loan
     • Both firms can save interest cost if each borrows in market in which ada interest cost advantage.

3. Movement in long n short term rates

   • Innterest rate , debt security during business recession
   • Advantage: If interest rate leh forecast, borrower leh pinjam bila rate rendah. Lenders target expansion of lending when interest high.
   • Disadvantage: Hard n impossible

4. Approaches to modern interest rate forecasting:

   • Concencus forecast: GDP, FDI
   • Market expectations: influence financial market, caused by public expectation
   • Econometric models: Use variables---> income, past inflation--> to predict interest rate
   • Money supply approaches: Factors--> liduidity, income--> effect of changes in nation's money supply
   • Fisher effect: Interest rate by lender=expecterd real ROR loan + expected rate inflation

5. Types of hedge in financial futures

   • Long hedge: Purchase of future contract today by investors n buy the securities @ later date
   • Short hedge: Sale of future contract today by investors n sell actual securities later point
   • Cross hedge: Underlying asset is different from actual asset yang kena trade @later date