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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 3 of 22
The real wordsTheory

Cash market and derivative market

The slide's own contrast, and it is the cleanest way to say what a derivative market is not.

Cash or spot market: actual market prices at the time of the transaction, immediate delivery, not suited for hedging, provides a liquidity advantage.

Derivative market: the financial market for instruments derived from other assets, divided into exchange-traded and over-the-counter halves.

The professor's line: cash markets trade assets, derivative markets trade contracts.

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