Derivative instrument: Difference between revisions

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''Risk management - hedging''.
A derivative instrument or contract is one whose value and other characteristics are derived from those of another asset or instrument (sometimes known as the Underlying Asset).
A derivative instrument or contract is one whose value and other characteristics are derived from those of another asset or instrument (sometimes known as the Underlying Asset).


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A share option is a type of derivative contract, allowing the holder to buy shares at a certain predetermined strike price.  
A share option is a type of derivative contract, allowing the holder to buy shares at a certain predetermined strike price.  


The value of the share option derives from the current price of the related underlying share relative to the option strike price.
The value of the share option derives from the current price of the related underlying share, relative to the option strike price.
 
 
For instance, say we hold a call option to buy shares at a strike price of $50, and the option is very close to its expiry date.
 
If the shares are trading at $90, our option to buy at $50 is valuable.
 
The option holder could exercise their option, paying $50 per share, and then sell the shares for $90 each, making a profit of $40 per share.
 
So the option itself is valuable.
 
We could sell the option for - roughly - $40 (per share).
 
 
On the other hand, if the share price were only $20, it wouldn't be rational to exercise an option to buy shares for $50.
 
It would be irrational to do that, because the shares are cheaper to buy in the market for $20 each.
 
Accordingly, the option isn't valuable at present.
 
 
The value of the option is being driven by - among other things - the share price.




== See also ==
== See also ==
* [[CertFMM]]
* [[Call option]]
* [[CCR]]
* [[Collateral]]
* [[Commercial paper]]  (CP)
* [[Commodity risk]]
* [[Commodity risk]]
* [[CPI fixing swap]]
* [[Credit support annex]]
* [[Embedded derivative]]
* [[Embedded derivative]]
* [[ETD]]
* [[ETD]]
* [[Expiry date]]
* [[FC]]
* [[Financial instrument]]
* [[Fixing instrument]]
* [[Fixing instrument]]
* [[Forward contract]]
* [[Forward rate agreement]]
* [[Futures contract]]
* [[FVTOCI]]
* [[FVTPL]]
* [[Hedge fund]]
* [[Hedge fund]]
* [[Hedging]]
* [[Hedging]]
* [[Interest rate derivative]]
* [[Interest rate swap]]
* [[ISDA Master Agreement]]
*[[Legal Entity Identifier Regulatory Oversight Committee]]  (LEI ROC)
* [[Leverage]]
* [[Margining]]
* [[Mark to market]]
* [[Maturity]]
* [[Maturity]]
* [[Notional principal]]
* [[Notional principal]]
* [[Option]]
* [[Option]]
* [[Outright]]
* [[Outright]]
* [[Potential Future Exposure]]
* [[Replacement cost]]
* [[Risk management]]
* [[Rogue trader]]
* [[Strike price]]
* [[Strike price]]
* [[Swap]]
* [[Tracker fund]]
* [[Tracker fund]]
* [[Transfer]]
* [[Underlying]]
* [[Underlying]]
* [[Underlying asset]]
* [[Underlying asset]]
* [[Underlying price]]
* [[Underlying price]]
* [[XVA]]
* [[X-Value Adjustment]] (XVA)
 


===Other links===
*[http://www.treasurers.org/node/8599  Masterclass: Derivatives, The Treasurer, December 2012]


*[http://www.treasurers.org/node/7849 Use and Misuse of Derivatives, Will Spinney, ACT 2012]
==Other resource==
*[http://www.treasurers.org/node/8599  Masterclass: Derivatives, ''Sarah Boyce,'' The Treasurer]


[[Category:Risk_frameworks]]
[[Category:Manage_risks]]

Latest revision as of 19:30, 20 November 2023

Risk management - hedging.

A derivative instrument or contract is one whose value and other characteristics are derived from those of another asset or instrument (sometimes known as the Underlying Asset).

Derivative instruments are widely used by non-financial corporates for hedging purposes.


Example

A share option is a type of derivative contract, allowing the holder to buy shares at a certain predetermined strike price.

The value of the share option derives from the current price of the related underlying share, relative to the option strike price.


For instance, say we hold a call option to buy shares at a strike price of $50, and the option is very close to its expiry date.

If the shares are trading at $90, our option to buy at $50 is valuable.

The option holder could exercise their option, paying $50 per share, and then sell the shares for $90 each, making a profit of $40 per share.

So the option itself is valuable.

We could sell the option for - roughly - $40 (per share).


On the other hand, if the share price were only $20, it wouldn't be rational to exercise an option to buy shares for $50.

It would be irrational to do that, because the shares are cheaper to buy in the market for $20 each.

Accordingly, the option isn't valuable at present.


The value of the option is being driven by - among other things - the share price.


See also


Other resource