十六 Asset Valuation Derivative Investments.docx
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十六 Asset Valuation Derivative Investments.docx
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十六AssetValuationDerivativeInvestments
十六AssetValuation:
DerivativeInvestments
1.A:
Introduction
a:
Definederivativeinstrument,arbitrageopportunity,forwardcontract,futurescontract,option(bothaputandacall),optiononfutures,andswap.
Afinancialderivativeisafinancialinstrumentwhosepayoffsdependonanotherfinancialinstrumentorasset.Forexample,anoptiononashareofstockdependsonthevalueoftheunderlyingpriceoftheshare.Thisbookdiscussesfourtypesofderivatives:
forwards,futures,options,andswaps.
Anarbitrageopportunityisthechancetomakearisklessprofitwithnoinvestment.Inarbitrage,youobservetwoidenticalassetswithdifferentprices.
Aforwardcontractisacontractnegotiatedinthepresentthatgivesthecontractholderboththerightandfulllegalobligationtoconductatransactionataspecificfuturetimeinvolvingaspecificquantityandtypeofassetatapredeterminedprice.
Afuturescontractisaforwardcontractthathasbeenhighlystandardizedandcloselyspecified.Aswithaforwardcontract,afuturescontractcallsfortheexchangeofsomegoodatafuturedateforcash,withthepaymentforthegoodtooccuratthefuturedeliverydate.
Anoptionscontractgivesitsownertheright,butnotthelegalobligation,toconductatransactioninvolvinganunderlyingassetatapredeterminedfuturedateandatapredeterminedprice(calledtheexerciseorstrikeprice).Options,however,onlygivethelongpositiontherighttodecidewhetherornotthetradewilleventuallytakeplace.
Aswapisanagreementbetweentwoormorepartiestoexchangesetsofcashflowsoveraperiodinthefuture.Thepartiesthatagreetotheswapareknownascounterparties.Thecashflowsthatthecounterpartiesmakearegenerallytiedtothevalueofdebtinstrumentsorthevalueofforeigncurrencies.Therefore,thetwobasickindsofswapsareinterestrateswapsandcurrencyswaps.
b:
Discusstheno-arbitrageprinciple.
Sinceanyobservedpricingerrorswillbeinstantaneouslycorrectedbythefirstpersontoobservethem,anyquotedpricemustbefreeofallknownerrors.Thisisthebasisbehindthetext’sno-arbitrageprinciple,whichstatesthatanyrationalpriceforafinancialinstrumentmustexcludearbitrageopportunities.Theno-arbitrageopportunityassumptionisthebasicrequirementforrationalpricesinthefinancialmarkets.Thismeansthatmarketsandpricesareefficient.Thatis,allrelevantinformationisimpoundedintheasset’sprice.
c:
Distinguishbetweenafuturescontractandaforwardcontract.
∙Forwardsareprivatecontractsanddonottradeonanorganizedexchange.Futurescontractstradeonorganizedexchanges.
∙Forwardsareuniquecontractssatisfyingtheneedsofthepartiesinvolved.Futurescontractsarehighlystandardized.Afuturescontractspecifiesthequantity,quality,deliverydate,anddeliverymechanism.
∙Forwardshavedefaultrisk.Thesellermaynotdeliverandthebuyermaynotacceptdelivery.Withfuturescontracts,performanceisguaranteedbytheexchange’sclearinghouse.
∙Forwardsrequirenocashtransactionsuntilthedeliverydate.Futurescontractsrequirethattraderspostmarginmoneytotrade.Marginisgoodfaithmoneythatsupportsthetrader’spromisetofulfilltheirobligation.
∙Forwardcontractsareusuallynotregulated.Thegovernmentregulatesfuturesmarkets.
d:
Distinguishbetweenanoptionbuyerandanoptionwriter.
Theownerofacalloptionhastherighttopurchasetheunderlyinggoodataspecificpriceforaspecifiedtimeperiod,whiletheownerofaputoptionhastherighttoselltheunderlyinggoodataspecificpriceforaspecifiedtimeperiod.Toacquiretheserights,ownersofoptionsmustbuythembypayingapricecalledthepremiumtotheselleroftheoption.
Foreveryownerofanoption,theremustbeaseller.Theselleroftheoptioniscalledanoptionwriter.Youwillnoticewithoptionsthattherearefourpossiblepositions:
thebuyerofacalloption,thewriter(seller)ofacalloption,thebuyerofaputoption,andthewriter(seller)ofaputoption.Intheseagreements,therightsliewiththeowneroftheoption.Thebuyerpaysthepremiumandreceivestherighttobuyorselltheunderlyinggoodonspecificterms.Thewriterorselleroftheoptionreceivespaymentandpromisestosellorpurchasetheunderlyinggoodonspecifictermsatthediscretionoftheoptionowner.
e:
Explainhowfinancialderivativescontributedtomarketcompleteness.
Acompletemarketisoneinwhichanyandallidentifiablepayoffscanbeobtainedbytradingthesecuritiesavailableinthemarket.Thisisadesirablecharacteristicofafinancialmarketbecauseithelpsmarketparticipantsmaximizetheirwelfarebyenablingthemtofulfilltheirtradingneeds.
f:
Explainthemajorapplicationsoffinancialderivatives.
Speculation.Thederivativemarketsallowtraderstotakeawiderangeofhighriskpositions.Thisaddstothecompletenessofmarkets.
Riskmanagement.Derivativesprovideatoolforenablingindividualsandfirmstomanagetheirriskbyallowingthemtohedgetheirpositionsinthemarkets.Throughhedging,firmscanchoosetoshifttheirrisktomarketspeculators.
Theconceptofarbitrage.Derivativesmakeiteasiertoarbitrageawaymispricinginthemarkets.
Tradingefficiency.Tradersmayfindtradingfinancialderivativesmoreattractivethantradingtheunderlyingsecurity.Tradingmarketindexfuturesmaybecheaperandeasierthantakingapositioninadiversifiedportfolio,andinterestratefuturesmaybeagoodsubstituteforaportfolioofTreasurysecurities.Derivativemarketsarefrequentlymoreliquidandofferlowertransactionscoststhantheactualsecuritiesmarkets.
1.B:
FuturesMarkets
a:
Distinguishbetweenaspeculatorandahedger.
Traderscanbedescribedasspeculators(meaningtheyacceptthemarket’sriskinpursuitofprofits)orhedgers(meaningtheytradefuturestoreducesomepre-existingriskexposure).Shorthedgerswouldbefirmswhoowntheasset(likewheat)andwanttoreducetheirriskbysellingtheassetnow(shortthewheat)inthefuturesmarket.Longhedgerswouldbefirmswhoareshorttheasset(likeabakerwhohaspromisedtodeliverbread)andwanttoreducetheirriskbybuyingtheassetnow(goinglongwheat)inthefuturesmarket.
b:
Distinguishbetweenvolumeandopeninterest.
Theopeninterestisthenumberofcontractsthatarecurrentlyinexistence.Anopeninterestof100wouldimplythatthereare100shortpositionsinexistenceand100longpositioninexistence.Activityinthefuturesmarketsismeasuredbytradingvolume.Tradingvolumecanrepresenteitheranewcontractbeingcreatedbetweenabuyerandselleroranexistingcontractbeingtradedbyoneoftheexistingtraderstoanewtrader.
c:
Discusshowthestandardizationoffuturescontractpromotesmarketliquidity.
Amajordifferencebetweenforwardsandfuturesisthatfuturescontractshavestandardizedcontractterms.Futurescontractsspecifythequalityandquantityofgoodthatcanbedelivered,thedeliverytime,andthemannerofdelivery.Theexchangealsosetstheminimumpricefluctuation(whichiscalledtheticksize).Forexample,thebasicpricemovement,ortick,fora5,000-bushelgraincontractisaquarterofapointor$12.50percontract.Contractsalsohaveadailypricelimit,whichsetsthemaximumpricemovementallowedinasingleday.Forexample,wheatcannotmovemorethan20¢fromitsclosetheprecedingday.Themaximumpricelimitsexpandduringperiodsofhighvolatilityandarenotineffectduringthedeliverymonth.Theexchangealsosetsthetradingtimesforeachcontract.
d:
Discusstheroleoftheclearinghouseintradingfuturescontracts.
Eachexchangehasaclearinghouse.Theclearinghouseguaranteesthattradersinthefuturesmarketwillhonortheirobligations.Theclearinghousedoesthisbysplittingeachtradeonceitismadeandactingastheoppositesideofeachposition.Theclearinghouseactsasthebuyertoeverysellerandthesellertoeverybuyer.Bydoingthis,theclearinghouseallowseithersideofthetradetoreversepositionslaterwithouthavingtocontacttheothersideoftheinitialtrade.Thisallowstraderstoenterthemarketknowingthattheywillbeabletoreversetheirpositionanytimethattheywant.Tradersarealsofreedfromhavingtoworryabouttheothersideofthetradedefaulting,sincetheothersideoftheirtradeisnowtheclearinghouse.InthehistoryofU.S.futurestrading,theclearinghousehasneverdefaulted.
e:
Defineinitialmargin,maintenancemargin,variationmargin,dailysettlement(markingtomarket)andmargincall.
Tosafeguardtheclearinghouse,theexchangerequirestraderstopostmarginandsettletheiraccountsonadailybasis.Beforetrading,thetradermustdepositfunds(calledmargin)withtheirbroker.Thepurposeofmarginistoensurethattraderswillperformtheircontractualobligations.
Therearethreetypesofmargin.Thefirstdepositiscalledtheinitialmargin.?
Initialmarginmustbepostedbeforeanytradingtakesplace.Initialmarginisfairlylowandequalsaboutoneday’smaximumpricefluctuation.Themarginrequirementislowbecauseattheendofeverydaythereisadailysettlementprocesscalledmarking-the-account-to-market.Inmarking-to-marketanylossesforthedayareremovedfromthetrader’saccountandanygainsareaddedtothetrader’saccount.Ifthemarginbalanceinthetrader’saccountfallsbelowacertainlevel(calledthemaintenancemargin),thetraderwillgetamargincallandhavetodepositmoremoneyintotheaccounttobringtheaccountbackuptotheinitialmarginlevel.
f:
Calculatethepriceatwhich
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