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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 2 of 22
The real wordsTheory

The definition

DerivativeA financial security with a value that is reliant upon, or derived from, an underlying asset or group of assets.

The professor's own version adds the contractual side: a derivative is a financial contract whose value depends on, or is derived from, an underlying asset. Common underlying assets he names: equity, currency, commodity, interest rate, index. Types: forwards, futures, options, swaps.

The Drive deck adds that derivatives are usually leveraged instruments, which increases both their potential risks and their rewards.

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