Price and Value of Swaps
Remember that a swap contract involves a series of periodic settlements with a final settlement at maturity. Swap price (or par swap rate) is a periodic fixed rate that equates the present value (PV) of all future expected floating cash…
Comparison of Swaps and Forward Contracts
Recall that a swap is a derivative contract between two counterparties to exchange a series of future cash flows. In comparison, a forward contract is also an agreement between two counterparties to exchange a single cash flow at a later…
Value and Price of Futures Contracts
Recall that during the initiation of a forward commitment, no cash changes hands. Further, the forward commitment is neither a liability nor an asset to the buyer or the seller. As such, the value of both the forward contract and…
Why Forward and Futures Prices Differ
Forward and futures contracts share similar features; however, how they are traded and the resulting cash flows mean forward and futures contracts with the same underlying asset may trade at a different price. Causes of Differences 1. Mark-to-Market (MTM), Margining,…
Interest Rates Forward Contracts
The link between the spot and forward prices is determined by a risk-free interest rate which is regarded as the opportunity cost of holding an asset. Term structure implies that various interest rates are available depending on the time to…
Price and Value of Forward Commitments
The price of a forward commitment is agreed upon at the contract’s initiation and remains fixed until the contract’s maturity. Moreover, the price is also used in determining the basis on which the underlying will be traded in the future…
Use of Derivatives among Issuers
Financial intermediaries, investors, and issuers use derivative products to increase, reduce, or alter their exposure to an underlying to achieve their financial goals. With the development of derivatives accounting, these instruments are now reported on the balance sheet at their…
Benefits of Derivative Instruments
Benefits 1. Risk Allocation, Transfer, and Management Derivative instruments allow allocation, transfer, and management of risks without trading an underlying. The information on cash or spot market prices for financial instruments, goods, and services may assist an investor or issuer…
Forward Commitments vs. Contingent Claims
Derivatives typically fall into two classes: forward commitments or contingent claims. The primary difference between the two is based on rights and obligations. Forward commitments carry an obligation to transact, whereas contingent claims confer the right to transact but not…
