Reflection of the Course Readings
During this course reading, I found derivatives trading concepts to be the most interesting. Thus, derivatives refer to financial contracts that their value and value of the underlying asset is linked. As such, these contracts financial tools that are used by investors for various purposes such as hedging. The derivatives contracts include forwards and futures, options and swaps.
Forwards and futures are financial contracts that certain the amount of price that buyers purchase with the pre-agreed price and it outlines a specific date that a buyer will pay for the underlying asset. Forward contracts allow buyers to have specific amounts for the underlying asset in terms of quantity as well as the date that buyer is supposed to pay. Future contracts are not as flexible as forwarding contracts.
Whereas, options financial contracts that allow the buyer of the asset to have the choice of buying or selling the underlying asset for an already agreed price. Thus, the buyer is not obligated to purchase the asset. Under these contracts, the buyer can either buy or decline to buy an asset before or during the date of maturity.
As well, swaps contracts enable parties involved to exchange cash flow between, that is, fixed cash flow and floating cash flow. As such parties involved may conduct various swaps that include interest rate, commodity, and currency.
I found the topic interesting as the derivatives trading are crucial in the financial market due to the different impacts they have in financial markets. Derivative trading has various advantages that include; helps in protecting hedging risk exposure since the derivatives are connected to the value of the underlying asset. It helps in offsetting losses of the underlying asset if investor’s investments value goes in appositive direction. For example, if a financial institution agrees with a farmer the price of corn is $5 per bushels in 3 months for 1 million bushels; in three months the spot price will have the following outcome: the price of a bushel is higher, equal or lower to $5. The price is exact if there are no monies that parties owe to each other, the price is higher if the farmer owes the bank the money and it lower of the bank owes the farmer the money.
Also, derivate contracts are used in determining underlying asset price. For example, the spot prices of the futures can help to approximate the commodity price. Moreover, derivatives contract are used to improve financial market efficiency because it helps an investor to replicate the payoff of the assets at the maturity date. As such, “the prices of the underlying asset and the associated derivative tend to be in equilibrium to avoid arbitrage opportunities.” Also, it helps an investor to have access to the unavailable market. For example, a company can access a favourable interest rate that less than available interest rates using swaps contracts. Therefore, I found the derivate topic to interest as it discussed various sub-topics that were informative.
Word Count (480 words)