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Sem 5 Prep
← Money & BankingWhat a derivative is, and why

Formulas for this chapter

Contract value

Contract value = number of lots x lot size x price of the underlying

Any futures or options question. This is the exposure, not the cash required, and single units cannot be traded because the lot size is standardised.

lot size
Standardised quantity of the underlying that one contract represents
price
Price of the underlying, or the index level

Margin, leverage and the wipe-out move

Initial margin = margin % x contract value Leverage = contract value / margin = 1 / margin % Adverse move that erases the margin = margin %

To turn a contract value into the cash actually at stake, and to say how far the underlying can move before the position is in trouble.

margin %
Initial margin as a percentage of the entire contract value

Compound annual growth rate

CAGR = (Final / Initial)^(1/n) - 1

Reading the turnover and volume statistics on the India derivative-boom slides. Never divide total growth by the number of years.

n
Number of years between the two figures
Step 1 of 22
The ideaTheory

A bet on somebody else's price

A farmer will harvest wheat in three months and does not know what wheat will cost then. A miller has the same problem in reverse.

They agree a price today for a sale in three months. Neither of them owns any wheat right now. What they own is a contract whose value depends entirely on the price of wheat.

That contract is a derivative. It has no value of its own; it borrows all of it from something else. Every instrument in this chapter is a variation on that one sentence.

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