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…
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),…
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…
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…
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…
Flotation Costs
Flotation costs are expenses that are incurred by a company during the process of raising additional capital. The value of these flotation costs is related to the amount and type of capital being raised. Whenever debt and preferred stock are…
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…
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…
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…
