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BUSI 3405U (11)
Bin Chang (11)
Lecture 10

BUSI 3405U Lecture 10: Week 10

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BUSI 3405U
Bin Chang

Week 10 Derivatives 1.Short Poisiton Shares are mainly held in street name Canadian Depository for Securities (CDS) Brokerage firm accounts Individuals are book entries in brokerage accounts Short sale Borrow the shares from a broker Buy them back at a lower price (Week 8 margin accounts etc) For simplicity, we do not consider transaction costs, short selling costs, and other costs 2 Derivatives Contingent claims Securitys payoff is determined by or is contingent on that of other securities Derivative means not original 3 two basic contracts Forward or Futures contract Contract that obligates two parties to exchange a predetermined quantity of something at a fixed price sometime in the future Oldest contract is foreign exchange forward contracts Option contract Contract that gives the buyer the right but not the obligation to buy and sell a fixed quantity at a predetermined price sometime in the future. Seller is obliged to fulfill the contract if called on. Call options on stocks are the oldest traded contract Markets are Over the counter (OTC) largely between banks and big institutions: forwards, CDS, interest rate swaps, CDOs Exchange traded more retail oriented: future and option Critical Point Speculators Use derivatives to get exposure for profit Hedgers Use derivatives to remove exposure Derivatives by themselves are not risky it depends whether you have the underlying security Derivative losses have come from: Outright speculation Trader starts to lose and covers up losses by more trades Bad internal controls do not pick it up People not knowing what they are doing Orange County Sophisticated investors are often unsophisticated! Forward Contracts Agreement between parities Counterparty risk: the other party may defalt Flexible term Flexible amounts Contracts closed out with offsetting contract if funds dont materialise or come earlier Settlement at maturity Futures Contract Guaranteed by Canadian derivatives clearing corporation (CDCC) so no need to worry about counterparty risk Marked to market: at the end of each trading day, the margin account is adjusted to reflect the investors gain or loss. Daily marked to market reduces risk of nonfulfillment Initial margin Maintenance margin Normally closed out by offsetting transaction, what is important is the open interest: total number of contracts outstanding Fees to buy futures contracts
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