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…
Factors in Investment Analysis
Environmental, social and governance factors are collectively referred to by the acronym “ESG.” ESG integration is the practice of considering environmental, social, and governance factors in the investment process. Ideally, ESG integration should be implemented across all asset classes, including…
Beta and Cost of Capital of a Project
When estimating the cost of equity using the Capital Asset Pricing Model (CAPM), a reliable estimate of beta must be used. The beta for a company that is not publicly traded may be estimated using the pure-play method. In the…
Marginal Cost of Capital Schedule
The cost of the different sources of capital tends to change as a company raises additional capital, thereby resulting in a change in its weighted average cost of capital (WACC). The marginal cost of capital (MCC) schedule depicts this relationship…
