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Derivatives

• (1) Financial instruments whose return profile is linked to, or derived from, the movement of one or more underlying index or security, and may include a leveraging factor, or (2) financial contracts based upon notional amounts whose value is derived from an underlying index or security (interest rates, foreign exchange rates, equities or commodities).

• These are securities whose payoff depends (is derived from) the price of the underlying asset. There are two broad classes of derivatives, futures and forward contracts and options. A futures (or a forward) contract is an agreement to exchange an asset and pay for it sometime in the future. No cash is paid at the time of the agreement. The delivery price is determined at the time of the agreement.
An option gives the buyer the right (but not the obligation) to exchange the asset sometime in the future. A call option gives the buyer the right to buy the underlying asset at a fixed price. The put option gives the buyer the right to sell the underlying asset at a fixed price. See call and put.

 
 Embedded terms in definition
 Asset
Buy
Call option
Call
Cash
Contract
Delivery price
Delivery
Exchange rate
Exchange
Factor
Foreign exchange rate
Foreign exchange
Foreign
Forward contract
Forward
Futures
Future
Index
Instruments
Interest rate
Notional
Options
Option
Put option
Put
Return
Right
Securities
Security
Sell
Time
Underlying asset
Underlying
 
 Referenced Terms
 Actual hedging: Is the risk management of a position when a hedger has a bona fide long or short actual position and is involved in an offsetting transaction. This offset is usually in the Derivatives market.

 Alternative investments: Are usually investments other than mutual funds, certificates of deposit, or direct investments in equities and bonds. Some of these alternatives are: art, collectibles, commodities, commodity funds, commodity pools, Derivatives, foreign exchange, hedge funds, oil and gas, precious metals, and real estate ventures.

 Breakeven point: Is the level whereby an investor neither profits or loses. It is often used in options and other Derivatives trading. Aside from transaction costs such as commissions, fees or spreads, there is usually a premium involved. For example, the breakeven point for a purchase call would be the strike price plus the premium to establish the effective breakeven strike price or breakeven level. In the case of a purchased put, it would be the strike price of the put adjusted by the paid premium. The market has to move down through the strike price by an amount equal to the premium paid. This effectively means that the breakeven level is lower than the contract's exercise price.(1) The point at which gains equal losses. (2) The market price that a stock must reach for an option buyer to avoid a loss if the Option is exercised. For a Call, it is the strike price plus the premium paid. For a Put, it is the strike price minus the premium paid.

 Buckets: Refer to categories for securities or Derivatives. Some buckets refer to maturity classifications, such as, 3, 6, 12 month buckets. There are many other designations as well. The term can also refer to duration adjusted groups, option adjusted groups, and other predefined categories which represent a dominant, common feature.

 Comps or comparables: Refer to pricing or evaluation benchmarking efforts. In real estate the term is used to determine comparable properties for evaluation or assessment purposes. In the securities markets, the term has similar implications for pricing bonds, stocks, and Derivatives. For credit instruments, it refers to isolating the key pricing characteristics. Among these, are issuer, type of collateral or issue, maturity, maturity to first option date, average life, duration, option adjusted duration and so forth. In the case of a simple corporate bond, it would benchmark to a comparable life treasury and adjust for credit rating and other pertinent risk factors by a spread. This spread would be added to the prevailing treasury and indicate what a fair yield would before the corporate. For equity type securities, the process would involve finding similar companies in the same industry with similar economic profiles and outlooks. Among the considerations would be utility stock or internet stock, growth prospects, cashflow, EPS, value per hit, and other determinative factors. Effectively, the process is pricing, marking-to-market, or evaluating by analogy.

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