2204 LO (W1)

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Week 1 | Introduction 1. Define the term 'derivatives' A derivative is an instrument whose value depends on, or is derived from, the value of another asset. (Eg. forwards, futures, options and swaps) Underlying Asset: stocks(equity), currencies, interest rates, commodities, debt instruments 2. Explain the main uses of derivative contracts Derivative Contracts Forward - an OTC contract to buy or sell an asset at a certain time in the future for a certain price Futures - an ET contract to buy or sell an asset at a certain time in the future for a certain price Swap - an OTC contract to exchange one set of cash flows for another set of cash flows at regular intervals Options - an ET or OTC contract conferring the right but no obligations to buy or sell an asset by a certain date in the future for a certain price Main Uses - to hedge risks - to speculate (take a view on the future direction of the market) - to lock in an arbitrage profit - to change the nature of a liability - to change the nature of an investment without incurring the costs of selling one portfolio and buying another 3. Discuss the main differences between OTC and ET market OTC ET Forwards, Swaps, Options Futures, Options 1 Major banks act as market makers 2 The number of derivatives transaction per year in the OTC markets is smaller than ET markets 3 The average size of the transitions is much greater in the OTC markets than ET markets 4 OTC can be risker than ET due to default risk
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