Options, Futures and Other Derivatives: Global Edition

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This program provides a better teaching and learning experience—for you and your students. Here's how: A risk manager in company X (located in the U.S.) knows that his company is due to pay 10 million euros in 6 months, at the exchange rate of USD 1.1120 per euro. How can the risk manager hedge again foreign exchange risk using a call option? With over 200 post-graduate students selected from a pool of top applicants world-wide, a faculty recruited from the top departments internationally, and a steady flow of distinguished visitors, we have a stimulating environment for research and learning that is on par with the best in the world. Short exposure in a futures contract means the holder of the position is obliged to sell the underlying instrument at the contract price at expiry. The holder will make a profit if the price of the instrument goes down. Conversely, they will make a loss if the price of the underlying rises dramatically.

A futures contract is a standardized, legally binding agreement – traded in on an exchange – between two parties that specifies the price to trade a given asset (commodity or financial instrument) at a specified future date.Non-linear derivatives have an asymmetrical payoff profile, allowing for limited loss with unlimited potential gain. A forward contract is a non-standardized contract – traded in an over-the-counter market –between two parties that specifies the price and the quantity of an asset to be delivered in the future. That it’s non-standardized implies it cannot be traded on an exchange. Instead, they are traded in the OTC market. One party takes a long position and agrees to buy the underlying asset at a specified price on the specified date, while the other party takes a short position and agrees to sell the asset on that same date at that same price. Hedgers use derivatives to reduce or remove risk exposure. We have already discussed how hedging works above. Consider the following example where foreign exchange risk is hedged using options. Since the 2007-2009 financial crisis, OTC markets are, however, increasingly being regulated. Some of the regulations include: The required technical tools will be explained carefully, allowing students to learn the language and to be able to converse with derivatives professionals. Once the tools are in place, those same tools can then be applied to any derivative. Special emphasis will be put on those derivatives that shape the modern world.

For non-linear derivatives, the delta is not constant. Rather, it keeps on changing with the change in the underlying asset. Examples include the Vanilla European option, Vanilla American option, Bermudan option, etc. Uses of Derivatives A call option gives the holder the right but not the obligation to buy the underlying asset at the strike price before the expiration date. On the other hand, a put option gives the holder the right but not the obligation to sell the underlying asset at the strike price before the expiration date. Forwards Contracts In options, such as a European call option, the potential loss is capped at the premium paid, while gains can be unlimited if the underlying asset’s price moves favorably.Alternatively, the risk manager could buy the European put option to sell 10 million euros at an exchange rate of USD 1.1120. If in six months the exchange is less than USD 1.1120, the risk manager exercises the option by selling the received for USD 1.1120. On the other hand, if the exchange is greater than USD 1.1120, the option is not exercised, and the risk manager acquires a favorable exchange rate. Speculators Long exposure in a futures contract means the holder of the position is obliged to buy the underlying instrument at the contract price at expiry. The holder will make a profit if the price of the instrument goes up.

Non-linear derivatives, such as options, have an asymmetrical payoff profile, which is their distinguishing feature.

Contents

Suppose that company X enters into a long position to buy 10 million euros in six months. If the actual CAD- EUR exchange rate in six months is CAD 1.1200 per euro, calculate the profit to company X.