Derivatives Assignment Help
In commerce, a derivative is a financial security with a value derived from or is reliant upon a benchmark (underlying asset or group of assets). It can also be defined as a contract between two or more parties. The fluctuations in the underlying asset determine the price of a derivative. Some of the most common types of derivatives’ underlying assets include bonds, stocks, commodities, market indexes. Interest rates and currencies. They can be purchased through brokerages.
Derivatives trade on an exchange or over the counter (OTC). OTC derivatives make up a significant proportion of the derivatives market. However, they generally have a wide possibilityof counterparty risk, which is the danger of default by one of the parties involved in the transactions. OTC derivatives are traded between two private parties and are unregulated. Conversely, exchange-traded derivatives are heavily regulated and standardized.
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Understand the Basics of Derivatives
Our statistics tutors say that derivatives can be used to:
- Speculate an underlying asset’s directional movement
- Hedge a position
- Give leverage to holdings
Derivatives were initially used to balance exchange rates for internationally traded goods. Since national currencies always have differing values, there was a necessity for a system to account for the differences. Today, derivatives have many more uses and are based on a wide array of transactions. For example, there are derivatives based on weather data like the number of sunny days or the amount of rain in a particular region.
Imagine that you are a European investor, boasting of investment accounts all denominated in EUR (Euros). You decide to purchase shares of a company in America through the US exchange using USD. Now, while holding the stock, you are exposed to the exchange rate risk. This is the risk of the value of the USD decreases in relation to the EUR. If this happens, the profits you will make when selling the stock will be less valuable when converted to Euros. To hedge the exchange rate risk, you could purchase a currency derivative. This will lock you in a specific exchange rate. Currency swaps and currency futures are examples of derivatives that can be used to hedge this kind of risk.
An investor speculating that the Euro will appreciate compared to the dollar could profit by using derivatives that also rise in value with the Euro. Additionally, an investor using derivatives to speculate on the price movement of an underlying asset does not need to have a portfolio presence in the asset.
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Forms of Derivatives
There are a variety of derivatives that can be used for speculation, risk management, and leverage position. Our statistics assignment experts have discussed some of them below:
Popularly known as future contracts. It is an agreement between two parties for the purchase and delivery of an asset at an agreed price and future date. Futures contracts are standardized and traded on an exchange. Investors who want to speculate on the price of an underlying asset or hedge their risk can use this type of derivative. The two parties involved in the futures contract must fulfill the commitment of buying or selling the underlying asset.
- Forwards (Forward contracts)
Forward contracts are almost similar to futures. The only difference is they only trade over the counter, not on exchange. In a forward contract, the seller and the buyer can customize the terms,settlement process, and the size of the derivative. However, just like other OTC products, forward contracts have a higher degree of counterparty risk for both the sellers and the buyers. Counterparty risk means that the buyer or seller may not live up to the contract’s obligation.
Swaps are derivatives used to exchange one kind of cash flow with another. For example, a trader can switch from a variable interest rate loan to a fixed one using an interest rate swap. Swaps can also be created for currency exchange rate risk, cash flows from other business activities or default on loan risk. The most popular kind of derivatives are the swaps related to potential defaults and cash flows of mortgage bonds.
Like in a futures contract, options also involve an agreement between two parties to buy and sell an asset for a specific price in a predetermined future date. However, the critical difference is that in an option contract, the buyer is not obligated to exercise the agreement of buying or selling. An options contract is an opportunity only, not an obligation, while future contracts are obligations.
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Merits and demerits of Derivatives
Derivatives are handy tools for both investors and businesses. They offer practical ways of mitigating risks, locking in prices, and hedging against unfavorable movements at a limited cost. Moreover, derivatives are less expensive since they can often be purchased with borrowed funds. However, on the downside, derivatives are based on the price of another asset. Therefore, they are difficult to value. Also, OTC derivatives are difficult to evaluate and predict because they have counterparty risks.
Our statistics project helpers have summarized the advantages and disadvantages of derivatives below:
- An investor can lock in prices
- It supports hedging against risks
- Derivatives allow leverage of positions
- Supports portfolio diversification
- Extremely difficult to value
- If traded over the counter, derivatives are subject to counterparty default
- Some of the concepts involved are too complex to understand
- Derivatives are demand and supply factors sensitive
Statisticsassignmentexperts.com offers immaculate assistance with derivatives
Our talented experts are at your disposal 24 hours a day, seven days a week. Mentioned below are some of the topics that they can assist you with:
- Derivatives in hedging and risk management
- Theories of no-arbitrage asset pricing
- Framework; modern theory of contingent claims valuation by pde and martingale methods
- Applied Business Research and Statistics
- Design Of Experiments
- Quantitative Methods
- Application of these asset pricing methods to the pricing of vanilla and exotic options and corporate liabilities, forwards, futures, as well as fixed-income derivatives
- Stochastic Modeling and Bayesian Inference
- Quantitative Methods
- Time Series Analysis and Forecasting
- Pricing within a multi-period
- Mostly continuous-time
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