Study On How Derivatives Can Reduce Risk Finance Essay - Free Essay Example

Derivatives are based on the behaviour of the basic assets. Derivatives have a lot of purposes. It can be used to minimise risk. For that it is need to allow the investor to hedge an investment or exposure, and hence it should be act as a function as a sort of insurance policy against adverse market movements. It can also be used to get extra leverage for specialized market speculation. These are a type of contracts which can be used as underlying the assets. It is merely a contract between two parties and its value can be derived from the variations that have occurred in underlying the assets. Mostly the common underlying assts include stocks, bonds, commodities, currencies interest rates and market indexes. Commonly derivatives are characterised by high leverage. The ways to how to use derivatives are to hedge risks, to reflect a view on the future direction of the markets, to put a lock in an arbitrage profit, to change the nature of a liability and to change the nature of an investment without incurring the costs of selling one portfolio and buying another. A derivative can also be regarded as a kind of asset, the ownership of which entitles the holder to receive from the seller a cash payment or possibly a series of cash payments at some point in the future, depending in some pre-speci ¬Ãƒâ€šÃ‚ ed way on the behaviour of the underlying assets over the relevant time interval. In some instances, instead of a cash payment another asset might be delivered instead. In general an option is a derivative with a speci ¬Ãƒâ€šÃ‚ ed pay off function that can depend on the prices of one or more underlying assets. It will have speci ¬Ãƒâ€šÃ‚ c dates when it can be exercised, that is, when the owner of the option can demand payment, based on the value of the pay off function. Derivatives are used for a variety of purposes. They can be used to reduce risk by allowing the investor to hedge an investment or exposure, and hence function as a sort of insurance policy against adverse market movements Derivatives can also be used to gain extra leverage for specialized market speculation. It is important to know the types of the derivatives which are used common and that are Forwards, Futures, Options and swaps. A forward contract is an agreement which is used to buy or sell an asset at a certain time in the future for a certain price that is called delivery price. It can be differentiated with a current agreement to buy or sell immediately. Que 1 : (1) what is swap ?* Types of swaps There are five types of swaps and that are interest rate swaps , currency swaps, credit swaps, commodity swaps   and  equity swaps. There are also many other types. Here , the GPL plc represents a very large portion of smith portfolio. Therefore the portfolio could be regarded as non-diversified and is exposed to very large level of specific risk. In order to reduce the specific risk elements in this portfolio entering into the swap has the consequence on effect of diversifying on smith portfolio. These will reduce its exposure through the performance of GPL stock with an equivalence of same exposure to the performance of the FTSE. (2) The strategy of hedging smiths exposure to GPL could be either buy- sell strategy of the underlying securities or the use of swap. However, the swap is potentially more superior than the alternative strategy. Some of the reasons that could be suggested for these kind of view are In order to avoid being taxed on the capital gains. The swap will reduce smiths expose to GPL stock The transaction cost of buying and selling of shares in the cash market will be avoided by using the swap strategy The swa p can be implemented quickly in the simple transactions, whereby avoiding any risk of being exposed to GPLs performance during the transactional period of buying and selling. (b) (1) In view of the fact that GPL has out performed the FTSE 100 index, smith has to pay the difference .Therefore smith is exposed to personal liquidity and cash flow risk. (2) The broker has to pay and there is a high tendency that the broker could diffort. This is a counterparty risk (3) Smith is not hedged until it is able to enter into new swap . The possibilities of having the previous swap terms at a reasonable cost may elude in Question : 2 (a) Calculate the outcome of each strategy if the CAC is equal to 3500, 4000, or 4500 at expiration of the contracts in June Value of CAC at expiration Initial portfolio (no futures or contracts) Portfolio hedged with futures Portfolio issued with puts 3900 Portfolio issued with puts 4000 3500 3,500,000 4,000,000 3,870,000 3,400,000 4000 4,000,000 4,000,000 3,970,000 3,900,000 4500 4,500,000 4,000,000 4,470,000 4,400,000 Working: Value of CAC at expiration is 3500, 4000 and 4500. Initial portfolio can be calculated by multiplying the amount into 100* 10 That is 3500*100*10 = 3,500,000 4000*100*10 = 4,000,000 4500*100*10 = 4,500,000 It is happened because the manager is buying 100 puts and options and futures have a multiple of ÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ 10. The portfolio is hedged with futures is 4000 and that is multiplied into 100*10 (same as above). This is because the futures on the CAC in June trade at 4000. Portfolio issued with puts 3900 Here the strike price is 3900 and premium is 30 (ÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ per unit of index) Ie, 3500- 30 = 3470*100*10= 3,470,000 4000-30 = 3970*100*10= 3,870,000 4500-30 = 4470 *100*10= 4,470,000 Portfolio issued with puts 4000 Here the strike price is 4000 a nd the premium is 100 (ÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ per unit of index) Ie, 3500-100 = 3400*100*10= 3,400,000 4000-100 = 3900*100*10 = 3,900,000 4500-100 = 4400 *100*10= 4,400,000 (b) Recommend and justify a strategy to the portfolio manager According to, above table, it is recommended that it is better to buy the 100 puts with a strike rate of 3900 or buy 100 puts with a strike of 4000. Here he can apply the strategy of hedging with futures. First of all, long term bilateral contracts are negotiated with the buyer and the seller. Such agreements have disadvantages. It can be say that, first, they used to expose each party to the risk that the other party may do and face failures in terms of the contract. Thus, while they cover up the companies from commodity price risk, they expose them to credit risk. Secondly, the lack of anonymity of the buyer and seller may strategic disadvantages. Finally the market value of the contract may not be easy to determine, that may making it difficult to track gains and losses. To avoid these disadvantages, as an alternative strategy hedge with futures can be used. A future contract is an agreement to trade an asset on some future date, at a price that is locked in today. Futures contracts are traded anonymously on an exchange at a publically observed market price. In this, both the buyer and seller can get out of the agreement by selling it to a third party at the current market price. These futures contracts are basically designed to eliminate the credit risk. It is determined by the market which is based on the supply and demand for each delivery date. Protection against a drop in the market is provided by hedging with futures, however the manager is deprived of profit potential. Buying puts also provides protection in case of a drop in the market while it is still to keep most of the upside potential although the put premium is deducted from the portfolio value. Therefore the portfolio manager is advis ed to buy 100 puts with a strike price of 4000. Question no: 3 Hedge fund These are collective investments which has a purpose to make the money whether the market goes up or down or sideways. These types of funds can make money when the share prices are falling. It can be done by using some techniques that is by going long or short on a share. How does the hedge fund works? Whenever an investor goes short, it is believed that the equity will fall in value. There are two main ways that hedge funds can do this. The first is by shorting the stock, where the investor borrows a stock to sell it, with the hope it will decrease in value so they can buy it back at a lower price and keep the difference. However the hedge funds are not only limited to equities. They will invest in anything that makes them a profit, including foreign currency, bonds or commodities. The hedge fund would aim at ensuring that at end of the day the beta value of its portfolio is equal to zero. I n order to achieve this goal it would meet to sell short -shares from list B, the proceeds of the actions would be used to buy shares from list A for an equal amount. The hedge funds could take long short positions for up to a sum of  £ 50 million. Other strategies in the same way as this could be to borrow  £25 m worth of shares in the list B and the sell them short. Use the sale profit to buy  £25 m shares in list A. Deposit  £9m as maintenance margin. This is 18% that the hedge fund is required as a deposit. From this question, it can be seen that the paying margin is 18% of the value of the stock. We can see that hedge fund makes a lot of money in all aspects. It is advised him to sell shares from the list B as this list of shares are considered as overvalued and also it is expected that shares from list B will underperform the British index by 5 percent over the year . also it is better to buy the shares from the list A as this list of shares are considered as und ervalued and also it is expected that shares from list A will outperform the British index by 5 percent over the year. These buying and selling shares are for equal amount in such a way that the overall value of the portfolio with respect to the market will be equal to zero. It is advised him to keep  £1 million in cash and take  £9 million and deposit in the margin account. It is asked him to hedge fund to take long positions of  £50 million.  £9 M / 0.18= £50M It is say that good to borrow  £25 m of shares in list B from a broker and go short on these shares. Also advised to buy shares of worth £25 m from the list A. by doing these type of buying and selling the position in list A B will well established and portfolio will be zero. When looking at the invested amount  £50 m=  £9 m / 0.18 this is why  £9m is invested in the margin market. It enables him to go short or long with  £25 m. Abitrage pricing Arbitrage is the key to unders tanding the mathematics of derivative pricing. No arbitrage means that it is not possible to construct a strategy that on average makes a pro ¬Ãƒâ€šÃ‚ t higher than the risk free rate without taking some risks. This also imples that is not possible to construct a strategy that requires no cash input but has some positive probability of making pro ¬Ãƒâ€šÃ‚ ts without any risk of a loss. No arbitrage also implies that given two strategies with the same initial position, and guaranteed  ¬Ãƒâ€šÃ‚ nal positions, then these  ¬Ãƒâ€šÃ‚ nal positions must be equal. Otherwise, by going long the strategy with the higher  ¬Ãƒâ€šÃ‚ nal value and short the other we would generate an arbitrage. Similarly if two strategies have the same  ¬Ãƒâ€šÃ‚ nal value and involve the same risk they need to have the same initial value.

The Dubliners The Significance Of Ireland - 1322 Words

The Dubliners – The Significance of Ireland By: Adam Pasternak 250796941 Dr. Donaldson The Dubliners is collection of short stories by James Joyce where all of the stories occur in Ireland, mostly in the capital of Dublin. These stories take place in the early years of the 20th Century. These stories depict the typical Irish middle class life. During this time period, there was a very negative morale. England was still in control of Ireland and the people of Ireland were very bitter. The Irish people had difficult lives and struggled with their responsibilities to support their families or to simply find happiness. The stories demonstrate the desire for the characters to escape their lives in Ireland for a more desirable life somewhere†¦show more content†¦Indian battles out of a magazine. The narrator in the story wanted more of an escape. The narrator describes this desire, â€Å"real adventures do not happen to people who remain at home: they must be sought abroad.† (Joyce, 21) The boys skipped school to explore the ships along the wharf and the Pig eon House (the power plant in Dublin). When they were walking, they encountered an elderly man. The man was clearly very â€Å"old-school† as he told the boys that any boy seen talking to a girl should be whipped, and that he would be happy to do it himself. The boys immediately turned back, frightened. The adventure was a disappointment to the boys. This story could be interpreted in such a way that we can see that the boys clearly were not physically trying to escape, but that they were mentally trying to escape. Instead of reenacting the battles of the Romans, they pretended to be cowboys in America. The boys were physically in Ireland, but their minds were elsewhere. Ireland was very depressing at that time and the country was largely guided by religion. It was very hard to live the typical life we see today. Everyone was somewhat miserable in Ireland and in The Dubliners, while most would not admit it, everyone was thinking of the possibility of a happy life somewhere else, except no one actually left. If they did leave, they ended up coming back to Ireland. It is almost as if the characters were paralyzed, in the sense that they could not move away and leave Ireland.

Positive Effects of the British Colonization of India Essay

Many positive things happened during, and as a result of, the British colonization of India. When the East India Company took control of India in 1612, they began modernizing, westernizing, and industrializing India. This westernization included giving women more rights, an attempt to eliminate the caste system and the loss of many of the more backward Hindu religious beliefs such as the domination of women by men and denying an entire class of people any rights. British occupation also did things long term for India. The modern technology and western customs allowed India to become a burgeoning regional superpower. The colonization of India was helpful for India because it went a long way to modernize India, westernized India in†¦show more content†¦Some of these students, such as the political activist Mahatma Gandhi, were able to travel England to study at some of the most prestigious universities in the world. It is a fact that to be a successful, innovative country you need an educated population base; the building of these British schools facilitated this. The westernization of India was beneficial to India. The most influential thing was the introduction of Enlightenment ideas and a western-style democracies; which has proven to be one of the most successful models in history. This made them one of the most effective colonies and post colonial countries. One of the best examples of western political thought surfacing in India was the formation of the Indian National Congress. The Indian National Congress was made up of western-educated Indians, who had been taught the ways of the enlightenment. They initially advocated for self-rule within the British Empire. After the Amritsar Massacre in which the soldiers hired by the East India Trading Company fired on unarmed protesters, they began protesting for complete independence from Britain. The system they wanted to install to run India was a Western-Style democracy/republic. The Indian National Co ngress is still in existence today and played an instrumental role in setting up India’s current democratic government. Another good policy that was spawned out of westernization was the idea thatShow MoreRelatedWestern Colonization Essay1061 Words   |  5 Pagesever been colonized in the world. India is one of these countries that affected by the Britain very much. From 16th century to 20th century, British colonialist began the aggression and expanding. England had ever governed many countries by using force methods . Absolutely, India became the target because of its widely nature products and lack of military power. The ancient country was suffering the colonial bearing. 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However – as shown by the Sudanese and Rwandan Genocides—foreign influence, and the absence of it, plays a big role in causingRead MoreThe British Colonization Of India935 Words   |  4 PagesIndia was administrative regulated by British for practically a century, with independence from Britain not expanded up until comparatively lately in August 1947. British colonization had an amount of momentous influences on the district, and many of which had permanent legacies on the nation’s economic and social positions. Though some of these effects were helpful and positive for India, many rooted in British imperial benefits being prioritized over domestic benefits, which led to an uneven pattern

Moneyball Paper free essay sample

How the Detroit Took Home-Field from the Yanks Many average fans view baseball as merely a game or another sport. But when you shift from an average fan to a baseball fan that idea changes quickly. Baseball fans, partially because of their obsession with statistics, are often view as more intellectual than their average counterparts. Furthermore, baseball fans are aware of what is happening in the game even if it can’t be seen watching the game on television. Both these traits can be fully derived from insight given in George Will’s Men at Work and Michael Lewis’ Moneyball. These books provide the reader with a detailed look at the inside of the game. By using that insight a baseball fan should be able to understand the various strategies and what events proved critical in any given game. Game 2 of the ALDS between the Detroit Tigers is a good example. We will write a custom essay sample on Moneyball Paper or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page While any fan would agree that it was a thrilling game it takes knowing the overriding themes of both these authors to understand what were the turning points that led Detroit to victory. Game 1 of this series did not go as expected. Intense rainstorms forced the game to be played over two days and greatly affected the managerial strategies enacted by both teams. Because rain cancelled the game Friday after only 1 and a half innings, both teams opted to bring in their scheduled Game 2 starters to finish the game when it resumed Saturday. New York ended up winning that game 9-3, and taking a 1-0 series lead. That delay, however, put managers Jim Leyland (Detroit) and Joe Girardi (New York) in a precarious situation. Would they choose to resend out their aces on a day’s rest and risk injury and fatigue or would they rely on their number three starter and face the fact that both team’s ace would pitch only one game this series? Joe Giradi decided on the former by sending Freddy Garcia to the mound, a seasoned veteran enjoying coming off a solid regular season (12 wins, 3. 62 ERA). Leyland had a tougher decision to make. The reason Scherzer was in the three spot to begin with is that Leyland wanted him to pitch in Detroit, where he has had much more success. Since Scherzer is a fly ball pitcher, he is best suited for a spacious ballpark like Detroit’s. Yankees Stadium is the exact opposite, with a close right field wall in a place built for home runs. In the end Leyland decided to go with Scherzer, who had already had some success against the Yankees that season. The Tigers wasted no time getting on the scoreboard as their opportunistic offense scored two runs in the top of the 1st. After Garcia recorded two outs and gave up a single to the first three batters he faced, Miguel Cabrera, Detroit’s MVP candidate and American League Batting Champion, stepped up to the plate. Cabrera, who had 9 hits in his 23 career at-bats against Garcia (including three homeruns) hit a two-run homerun to right field, a shot that would not have been a homerun in most ballparks. Garcia, however, recollected himself and ended the inning with an emphatic strikeout of Victor Martinez. Tigers 2, Yankees 0. In the bottom of the inning, Max Scherzer retired both the legendary Derek Jeter and MVP candidate Curtis Granderson before facing the Yankees number three hitter, Robinson Cano. Cano had dominated the night before, knocking in six runs with two outs in a Yankees’ rout. To avoid potential disaster, Scherzer refused to throw Cano anything he could hit and walked him on four straight pitches. Scherzer then walked the next batter, Alex Rodriguez, and as Mark Teixeira approached the plate, the run thirsty Yankee fans went into an uproar. Facing a 3-1 count, Scherzer induced Teixeira to fly out, and successfully survived his first jam of the evening. Tigers 2, Yankees 0. The next couple innings were defined by dominant pitching. After a 1-2-3 out 2nd, Garcia gave up a two out single to Magglio Ordonez in the 3rd, his second in two at-bats. The threat was avoided though when Alex Rodriguez made a tremendous diving catch to record the third out.