The buyer of a forward rate agreement (FRA) locks in (secures) an interest rate. He protects himself against rising rates but, on the other side, also doesn’t profit from falling ones. The seller of an FRA is secured against falling interest rates as he invests the money at the locked-in interest rate.
If a call option is in the money, its strike price is lower than the underlying price. Formula: Underlying – Strike Price = Positive If a put option is in the money, it means that its strike price is higher than the price of the underlying. Formula: Strike Price – Underlying = Positive If an option is at the money, its strike price and underlying […]
If you are worried about interest rate fluctuations (eg. you want to buy a bond or take on a credit) you might use one of the following instruments: Cap If you are worried about rising interest rates (eg. you want to buy a bond) then a Cap might be the right thing for you. How does it work: If the […]
The European central bank (ECB) has 3 main ways to increase/decrease the money supply and : 1) Open market operations The main instrument for the ECB for controlling the liquidity on the market is “open market operations”. Their aim is to achieve a balance between liquidity demand and liquidity supply at a specified interest rate. Open market operations are usually […]
Hedging, either one wants to secure (lock-in) the price of future spot market positons ( long hedge ), or one wants to secure the price of currently owned spot market positions. Trading, one takes risks in order to make profits. In arbitrage, one tries to realize price differences of different positions (eg. a stock and future on that stock)
The (futures) exchange guarantees the fulfillment of the trades. The (futures) exchange calculates the payment obligations of the clearing members. (often even daily resettlement) The (futures) exchange allows effective pricing for the derivatives The (futures) exchange allows standardization (fixed quantity, fixed place, fixed delivery dates, standardized contract types) The standardization work of an exchange organization leads to more liquidity for […]
With a swap, you exchange future cash flows with another investor (usually in the same currency – that’s also called a plain vanilla swap). For example, you could exchange interest rates. Let’s assume you feel that the interest rate will decrease while another investor wants to secure himself against rising interest rates. Therefore you might want a variable interest rate […]
If you buy a spot market instrument you have to bare the total cost of carry (financing costs) immediately at the point you buy it. On the other side, if you buy a future you can bare the financing costs at a later point. Therefore it seems reasonable that a future will cost more. (Money you have now is always […]
Bull spead: You expect underlying prices (eg. stock prices) to rise (slightly) Bear spead: You expect underlying prices (eg. stock prices) to fall (slightly).(black horizontal line is the price of the underlying)
Short Straddle: If you believe the market volatility will be low in the upcoming days/weeks a short straddle might be the right option strategy for you. You buy a short call as well as a short put. Probably the buyer of the call and put won’t exercise his options and you make a profit (2 x premium) Long Straddle: If […]