Derivative-markets-PowerPoint presentation

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1. Derivative marketDerivative market
1. Concept of derivative market1. Concept of derivative market
2. Participants of derivative market2. Participants of derivative market
3. Instruments of derivative market3. Instruments of derivative market

2. 1. Concept of derivative market1. Concept of derivative market

The The derivatives marketderivatives market is the is the financial market
for for derivatives, , financial instruments like futures like futures
contracts or options, which are derived from contracts or options, which are derived from
other forms of other forms of assets..

The market can be divided into two, that for The market can be divided into two, that for
exchange-traded derivatives and that for and that for
over-the-counter derivatives. The legal nature of . The legal nature of
these products is very different as well as the these products is very different as well as the
way they are traded, though many market way they are traded, though many market
participants are active in both.participants are active in both.

3. 
There are actually two distinct forms of the There are actually two distinct forms of the
derivative market. It is possible to purchase and derivative market. It is possible to purchase and
sell derivatives in the form of sell derivatives in the form of futures or as over- or as over-
the-counter offerings. It is not unusual for the-counter offerings. It is not unusual for
investors who are interested in derivatives to investors who are interested in derivatives to
actively participate in actively participate in bothboth of these financial of these financial
markets. markets.

In the case of futures, there are futures markets In the case of futures, there are futures markets
around the world that allow trading that involves around the world that allow trading that involves
derivative contracts. In the United States, the derivative contracts. In the United States, the
Chicago Mercantile Exchange is an example of a Chicago Mercantile Exchange is an example of a
derivative market that trades futures. In this type derivative market that trades futures. In this type
of of financial market environment, the exchange environment, the exchange
functions as a counterparty to members engaged functions as a counterparty to members engaged
in buying and selling activity. in buying and selling activity.

4. 
The process for investing in futures in a derivative market The process for investing in futures in a derivative market
works by establishing a situation where one party sells works by establishing a situation where one party sells
one one futures contract while the counterparty purchases a while the counterparty purchases a
new futures contract. The result of the two transactions new futures contract. The result of the two transactions
effectively produces a position that is considered to be at effectively produces a position that is considered to be at
zero. This approach essentially transfers the bulk of the zero. This approach essentially transfers the bulk of the
risk to the counterparty in the arrangement and makes it risk to the counterparty in the arrangement and makes it
possible to earn a return by exchanging a possible to earn a return by exchanging a long position for for
a short one. a short one.

Along with futures, a derivative market situation may also Along with futures, a derivative market situation may also
exist in over-the-counter or OTC markets. In this scenario, exist in over-the-counter or OTC markets. In this scenario,
the derivatives focus on larger clients such as government the derivatives focus on larger clients such as government
entities, entities, investment banks and hedge funds. Trading on and hedge funds. Trading on
these markets can involve several different types of these markets can involve several different types of
options, including credit derivatives. The volume of the options, including credit derivatives. The volume of the
trading activity is substantial, involving significant amounts trading activity is substantial, involving significant amounts
of resources on the part of the investors involved. of resources on the part of the investors involved.

5. The appeal of a derivative market has to do with The appeal of a derivative market has to do with
the potential for a larger return than is usually the potential for a larger return than is usually
the case with other forms of investment. In like the case with other forms of investment. In like
manner, the ability to transfer the liability from manner, the ability to transfer the liability from
one party to another is also appealing in some one party to another is also appealing in some
situations. While it is true that derivatives can be situations. While it is true that derivatives can be
somewhat volatile, the fact is that many of the somewhat volatile, the fact is that many of the
trades conducted on a derivative market carry trades conducted on a derivative market carry
no more risk than in investment markets. As long no more risk than in investment markets. As long
as the investor performs due diligence as it as the investor performs due diligence as it
relates to understanding past, current, and relates to understanding past, current, and
projected performance, it is possible to do very projected performance, it is possible to do very
well in a derivatives market. well in a derivatives market.

6. Why derivative market is neededWhy derivative market is needed

will allow considerably to multiply will allow considerably to multiply
liquidity at the marketliquidity at the market

cheap and effective method of cheap and effective method of
management by the risksmanagement by the risks
It is the instrument of increase of It is the instrument of increase of
efficiency of basic marketefficiency of basic market
It promotes strength security of It promotes strength security of
financial investmentsfinancial investments
it is inalienable part of the developed it is inalienable part of the developed
financial marketfinancial market

7. New possibilities for investorsNew possibilities for investors

hedginghedging

absence 100% of pre-depositingabsence 100% of pre-depositing

the guarantee system of urgent market the guarantee system of urgent market
provides execution of transactionsprovides execution of transactions

new instruments of investing new instruments of investing

wide spectrum of choice of base assetwide spectrum of choice of base asset

the volume of the opened positions is the volume of the opened positions is
unreserved by the real volume of base unreserved by the real volume of base
assetasset

8. FUNCTIONS OF DERIVATIVE FUNCTIONS OF DERIVATIVE
MARKETMARKET

MANAGEMENT BY RISKMANAGEMENT BY RISK

insurance from the risk of unfavorable change of insurance from the risk of unfavorable change of
cost of base assetcost of base asset

redistribution of risks between all participantsredistribution of risks between all participants

INFORMATIVEINFORMATIVE

reflects expectation of many participants of reflects expectation of many participants of
marketmarket

SPECULATIVESPECULATIVE

possibility to trade with the effect of shoulderpossibility to trade with the effect of shoulder

possibility of sales without coveragepossibility of sales without coverage

9. 2. Participants of derivative market2. Participants of derivative market
At the derivative market three categories of participants are At the derivative market three categories of participants are
selected, depending on that purpose which they pursue.selected, depending on that purpose which they pursue.
A speculatorA speculator is a subject is a subject that aspiring to get an income due that aspiring to get an income due
to a difference in the courses (prices) of financial instruments, to a difference in the courses (prices) of financial instruments,
which can arise up in time. This market attracts speculators by which can arise up in time. This market attracts speculators by
possibility of the use of free financial leverage . because one possibility of the use of free financial leverage . because one
of features of this market is that all sum for a financial asset is of features of this market is that all sum for a financial asset is
not paid at once, on the account of client a mortgage, so-not paid at once, on the account of client a mortgage, so-
called guarantee providing which makes a certain percent called guarantee providing which makes a certain percent
from the value of the contract, is only blocked. Daily on results from the value of the contract, is only blocked. Daily on results
auctions to the clients is charged extra or a variation margin auctions to the clients is charged extra or a variation margin
depending on direction of motion of market holds out. depending on direction of motion of market holds out.
The purpose of speculators consists of extraction of The purpose of speculators consists of extraction of
income due to the «game» on vibrations of courses of income due to the «game» on vibrations of courses of
financial instruments circulating at the market. They financial instruments circulating at the market. They
assume all risks of price-wave at the market and they can assume all risks of price-wave at the market and they can
get also losses.get also losses.

10. Arbitrageur Arbitrageur is person that gets an income due to the is person that gets an income due to the
simultaneous purchase-sale of the same asset at the different simultaneous purchase-sale of the same asset at the different
markets, if there are different prices on them, or associate markets, if there are different prices on them, or associate
assets at violation between them of parity relations.assets at violation between them of parity relations.
Classic example of arbitration operation: arbitrageur buys in a spot-market a financial asset (share) Classic example of arbitration operation: arbitrageur buys in a spot-market a financial asset (share)
and simultaneously sells the futures contract on the same share at more high price, or vice and simultaneously sells the futures contract on the same share at more high price, or vice
versa, if the futures contract on the same share is below than cost of this share, arbitrageur versa, if the futures contract on the same share is below than cost of this share, arbitrageur
buys the futures contract and sells share. Coming from that at the end of term of appeal of the buys the futures contract and sells share. Coming from that at the end of term of appeal of the
futures contract it will cost so much, as and share in a spot-market, it is possible to do a futures contract it will cost so much, as and share in a spot-market, it is possible to do a
conclusion, that a difference in prices in the moment of transaction will be reached arbitrageur conclusion, that a difference in prices in the moment of transaction will be reached arbitrageur
without the risk. without the risk.
Profitableness of riskfree operations makes only 15 - 20 % annual. Profitableness of riskfree operations makes only 15 - 20 % annual.
By the purpose of arbitrageur, as well as speculators, there is extraction By the purpose of arbitrageur, as well as speculators, there is extraction
of income. However extracted the income of arbitrageur is without of income. However extracted the income of arbitrageur is without
some risk due to the sometimes nascent temporal disbalance of some risk due to the sometimes nascent temporal disbalance of
prices on the same assets or at the different (in geographical sense) prices on the same assets or at the different (in geographical sense)
markets, or at the same markets at the disbalance of prices in time. It markets, or at the same markets at the disbalance of prices in time. It
is natural income of arbitrageur substantially less, than at speculators. is natural income of arbitrageur substantially less, than at speculators.
It is related to that principle of «market justice» dominates at the It is related to that principle of «market justice» dominates at the
market, in accordance with which «anymore risk - anymore income» market, in accordance with which «anymore risk - anymore income»
and, accordingly, vice versa «less risk - less income». and, accordingly, vice versa «less risk - less income».

11. Hedger Hedger is is one who attempts to transfer the risk of price change by
taking an opposite and equal position in the futures or futures option
market from that position held in the cash
A person who uses the markets to reduce the risk of his underlying
position by undertaking a hedge. For example, a wheat farmer may
sell wheat
 
futures 
to guarantee him a fixed selling price for his
wheat.
Hedging is Hedging is the method of management by the risk,
but pay of investor for the release from the risk
is the received less profit
Purpose of hedger consists of insurance of Purpose of hedger consists of insurance of
results of the financial activity at the spot results of the financial activity at the spot
market due to the conclusion of additional market due to the conclusion of additional
contracts at the urgent market.contracts at the urgent market.

12. 3. Instruments of derivative market3. Instruments of derivative market
Derivatives are securities, or financial Derivatives are securities, or financial
instruments, that get their value, or at least part instruments, that get their value, or at least part
of their value, from the value of another of their value, from the value of another
security, which is called the underlier. The security, which is called the underlier. The
underlier can come in many forms including, underlier can come in many forms including,
commodities, mortgages, stocks, bonds, or commodities, mortgages, stocks, bonds, or
currency. currency.
The reason investors may invest in a derivative The reason investors may invest in a derivative
security is to hedge their bet. By investing in security is to hedge their bet. By investing in
something based on a more stable underlier, something based on a more stable underlier,
the investor is assuming less risk than if the investor is assuming less risk than if he/he/she she
invested in an risky security without an invested in an risky security without an
underlier.underlier.

13. To derivativesTo derivatives concern:concern:

1. Forward contracts1. Forward contracts

2. Future contracts2. Future contracts

3. Option3. Option

4. Swaps 4. Swaps

5. 5. Preemptive RightsPreemptive Rights

6. Warrant6. Warrant

Depending on a kind of values derivative divide on:Depending on a kind of values derivative divide on:

- The share- The share

- The currency - The currency

- The commodity- The commodity

14. Particularities of derivative securities:Particularities of derivative securities:

1) their price is based on the price, an exchange active 1) their price is based on the price, an exchange active
laying in their basis in which quality other securities can laying in their basis in which quality other securities can
act;act;

2) the external form of the reference of derivative 2) the external form of the reference of derivative
securities is similar to the reference of the basic securities is similar to the reference of the basic
securities;securities;

3) the limited time period of existence (from several days 3) the limited time period of existence (from several days
about several months) in comparison with the period of a about several months) in comparison with the period of a
life of an exchange active (stocks – term less, bonds - life of an exchange active (stocks – term less, bonds -
years and decades);years and decades);

4) their purchase and sale allows to receive profit at the 4) their purchase and sale allows to receive profit at the
minimum investments in comparison with other minimum investments in comparison with other
securities as the investor pays not all cost of an active securities as the investor pays not all cost of an active
but only guarantee (marginal) a payment.but only guarantee (marginal) a payment.

15. Preemptive Rights / Preemptive Rights /
Subscription rightsSubscription rights
The preemptive rightThe preemptive right allows common allows common
stockholders to maintain their proportistockholders to maintain their proportiononate ate
ownership in the corporation when new shares ownership in the corporation when new shares
are issued. The preemptive right allows existing are issued. The preemptive right allows existing
shareholders to maintain voting control and shareholders to maintain voting control and
protect against the dilution of their ownership. protect against the dilution of their ownership.
Dilution of ownership usually results in the dilution Dilution of ownership usually results in the dilution
of earnings, because each present shareholder of earnings, because each present shareholder
has a claim on a smaller part of the firm's has a claim on a smaller part of the firm's
earnings than previously.earnings than previously.

16. In a rights offering, the firm grants rights to its In a rights offering, the firm grants rights to its
shareholders. These financial instruments shareholders. These financial instruments
permit stockholders to purchase additional permit stockholders to purchase additional
shares at a price below the market price, in shares at a price below the market price, in
direct proportion to their number of owned direct proportion to their number of owned
shares. shares.
A shareholder can take advantage of these A shareholder can take advantage of these
rights, purchasing the indicated amount of rights, purchasing the indicated amount of
shares or to sell rights to other person.shares or to sell rights to other person.

There is registration data, and for four days to There is registration data, and for four days to
it is it is date of receipt of rights.date of receipt of rights. To this date the To this date the
cost of right can be calculated on a formula:cost of right can be calculated on a formula:

17. PoPo – (RoN + S) = Ro– (RoN + S) = Ro
where where PPoo is market price of share; is market price of share;
RRoo is a cost of right; is a cost of right;
N N is number of rights necessary for the purchase of one is number of rights necessary for the purchase of one
share;share;
SS is subscription price. is subscription price.
Ro =(PRo =(Poo – S) / (N +1) – S) / (N +1)
At the offensive of date of receipt of rights to favourable At the offensive of date of receipt of rights to favourable
acquisition of shares and after it the cost of right can be acquisition of shares and after it the cost of right can be
calculated on a formula:calculated on a formula:
PxPx – (Rх N + S) = 0,– (Rх N + S) = 0,
where where PxPx is market course of share after the date of is market course of share after the date of
receipt of rights to favourable acquisition of share.receipt of rights to favourable acquisition of share.
Rх = (Px – S) / N.Rх = (Px – S) / N.
Px=(Po*N+S) /N+1Px=(Po*N+S) /N+1

18. 
Difference from the warrant consists that Difference from the warrant consists that
period of validity of the subscription period of validity of the subscription
rights is limited by time of a subscription rights is limited by time of a subscription
for company new shares.for company new shares.

19. Warrant - is a security which is issued by Warrant - is a security which is issued by
the issuer together with their own the issuer together with their own
preferred shares or bonds and gives the preferred shares or bonds and gives the
owner the right to purchase common owner the right to purchase common
shares of the issuer for a period at a fixed shares of the issuer for a period at a fixed
price. price.
Possession of warrant makes it possible to Possession of warrant makes it possible to
make profit by the difference of exchange make profit by the difference of exchange
common and preferred shares and bonds common and preferred shares and bonds
(with increasing value of ordinary shares).(with increasing value of ordinary shares).
WarrantWarrant