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Understanding Financial Derivatives: Forwards, Futures, Options, and Swaps Explained

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This document provides a comprehensive overview of financial derivatives, defined as instruments derived from underlying assets. It covers the four main types of derivatives: forwards, futures, options, and swaps. Each type is explained in detail, highlighting their characteristics and differences. Forwards are tailored agreements between parties, while futures are standardized contracts traded on exchanges. Swaps involve exchanging cash flows between entities. Real-world examples illustrate the concepts, making it easier to grasp these complex financial tools.

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Understanding Financial Derivatives: Forwards, Futures, Options, and Swaps Explained

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  1. DERIVATIVES FATIMA RAZA (1917/FMS/BBA/S07) KAUSAR WAHAB (1924/FMS/BBA/S07) NITASHA MUBASHAR (1934/FMS/BBA/S07)

  2. KAUSAR WAHAB

  3. DERIVATIVES “A derivative is a financial instrument that is derived from some other asset, index, event, value or condition (known as the underlying asset)”

  4. TYPES OF DERIVATIVES TYPES OF DERIVATIVES Four main types of derivatives: Forwards Futures Options Swaps

  5. FORWARDS FORWARDS “ A forward contract is an agreement between a corporation and a commercial bank to exchange a specified amount of a currency at a specified exchange rate (called the forward rate) on a specified date in future”

  6. FORMULA FOR FORWARDS FORMULA FOR FORWARDS F=S (1+p) Where S=Spot Rate p=premium

  7. FUTURES • FUTURES “A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price”

  8. FORWARDS Vs FUTURES • Tailored to individuals need • Expiry date and contract size depends on the transaction • Negotiated directly by the buyer and seller • Standardized • Standardized contract size n expiry date • Quoted and traded on the Exchange FORWARDS FUTURES

  9. NITASHA MUBASHIR

  10. SWAPS “A Swap is a contract between two parties to deliver one sum of money against another sum of money at periodic intervals”

  11. TYPES OF SWAPS

  12. INTEREST RATE SWAP “An exchange of fixed interest payment for floating interest payments by two counterparties is called interest rate swap”

  13. TERMINOLOGIES USED

  14. WHY DO FIs SWAP???

  15. EXPLAINATION OF INTEREST RATE SWAP

  16. POSITION OF COMPANY ABC ABC COMPANY Bond Issued Fixed Rate Receiver (Return) Floating Rate Payment (Cost) Loan to Public PUBLIC PUBLIC

  17. POSITION OF COMPANY XYZ XYZ COMPANY Fixed Rate Payment (Cost) Floating Rate Receiver (Return) Loan to Public Bond Issued PUBLIC PUBLIC

  18. In swap contract: (buyer) In swap contract: (seller) Floating rate receiver Floating rate payment Fixed rate payment Fixed rate receiver XYZ COMPANY ABC COMPANY Swap contract Fixed Floating Floating Fixed Rate RateRateRate Receiver Payment Receiver Payment PUBLIC PUBLIC

  19. THE END

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