Valuating and Calculating Returns on Alternative Investments
Hedge Funds Valuating and calculating returns for hedge funds include issues such as the difference between fund performance and investor performance (net-of-fees, redemption issues). The use of high leverage in hedge funds can amplify gains and losses. Investors must, therefore,…
Risk Management and Due Diligence for Alternative Investments
Due diligence for hedge fund selection includes looking at the track record (if any), investment strategies, redemption rules, and many other qualitative and quantitative factors. Private equity funds require investors to look at the track record. The investment horizon is…
Exercise Value, Time Value, and Moneyness of an Option
The exercise value, time to expiry, and price of the underlying relative to the option’s exercise price all affect the price of the option. Exercise Value of an Option The exercise value of American and European options is different because…
Derivatives – Exchange Traded & OTC
Derivatives are a class of financial instruments that derive their value from the performance of basic underlying assets. These underlying assets can be equities (stocks), fixed income instruments (bonds), currencies, or commodities traded in cash or spot markets at cash…
Forward Commitments versus Contingent Claims
Derivatives typically fall into one of two classifications, either forward commitments or contingent claims. The primary difference between the two is around obligations. Forward commitments carry an obligation to transact, whereas contingent claims confer the right to transact, but not…
Types of Derivative Contracts
There are multiple types of derivative contracts that are classified as forward commitments or contingent claims. Within the forward commitment universe, we find forward contracts, futures contracts, and swaps. On the other side of the spectrum, options (calls and puts),…
Purpose and Controversies of Derivative Markets
The primary purpose behind derivative contracts is the transfer of risk without the need to trade the underlying. This allows for more effective risk management within companies and the broader economy. In addition, the derivatives market plays a role in…
The Role of Arbitrage
In well-functioning markets with low transaction costs and a free flow of information, the same asset cannot sell for more than one price. If the same asset trade at a higher price in one place and a lower price in…
Call & Put Option Profits and Payoffs
Call and put options have basic formulas for determining the value, profit, and break-even point at expiration, dependent on whether the investor has bought or sold the option. Using these basic characteristics, more complex option strategies can be evaluated. Standard…
Covered Calls and Protective Puts
Call and put options can be used to manage risk for holders of the underlying risk. Two common strategies are to reduce exposure by using a covered call (selling a call option) or to use a protective put (buying a…
