The Lehman Bankruptcy (BusinessSnapshot 1.10)6Lehman's filed for bankruptcy on September 15, 2008This was the biggest bankruptcy in US historyLehman was an active participant in the OTC derivatives+markets and got into financial difficulties because it tookhighrisks and found it was unableto roll over its shortterm fundingIt had hundreds of thousands of transactionsoutstanding withabout 8,o00 counterpartiesUnwinding these transactions has been challenging forboth the Lehman liquidators and their counterpartiesOptions,Futures,andOtherDerivatives,8thEditionCopyrightJohnC.Hull20126
The Lehman Bankruptcy (Business Snapshot 1.10) Lehman’s filed for bankruptcy on September 15, 2008. This was the biggest bankruptcy in US history Lehman was an active participant in the OTC derivatives markets and got into financial difficulties because it took high risks and found it was unable to roll over its short term funding It had hundreds of thousands of transactions outstanding with about 8,000 counterparties Unwinding these transactions has been challenging for both the Lehman liquidators and their counterparties Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 6
How Derivatives are UsedTo hedge risks8To speculate (take a view on thefuture direction of the market)To lock in an arbitrage profitTo change the nature of a liabilityTo change the nature of an investmentwithout incurring the costs of sellingoneportfolio and buying anotherOptionsFutures,andOtherDerivatives,8thEditionCopyrightJohnC.Hull2012
How Derivatives are Used To hedge risks To speculate (take a view on the future direction of the market) To lock in an arbitrage profit To change the nature of a liability To change the nature of an investment without incurring the costs of selling one portfolio and buying another Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 7
Foreign ExchangeQuotesfor GBPMay 24, 2010 (See page 5)BidOfferSpot1.44071.44111.44081.44131-month forward1.44101.44153-monthforward1.44161.44226-monthforwardOptions,Futures,andOtherDerivatives,8thEdition,8Copyright John C.Hull 2012
Foreign Exchange Quotes for GBP, May 24, 2010 (See page 5) Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 8 Bid Offer Spot 1.4407 1.4411 1-month forward 1.4408 1.4413 3-month forward 1.4410 1.4415 6-month forward 1.4416 1.4422
Forward PriceThe forward price for a contract is theodelivery price that would be applicable tothe contract if were negotiated today(i.e., it is the delivery price that wouldmake the contract worth exactly zero)The forward price may be different forHcontracts of different maturities (asshown by the table)OptionsFutures,andOtherDerivatives,8thEditionCopyrightJohnC.Hull20129
Forward Price The forward price for a contract is the delivery price that would be applicable to the contract if were negotiated today (i.e., it is the delivery price that would make the contract worth exactly zero) The forward price may be different for contracts of different maturities (as shown by the table) Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 9
Terminology8 The party that has agreed to buyhas what is termed a long positionThe party that has agreed to sellhas what is termed a short positionOptionsFutures,andOtherDerivatives,8thEditionCopyrightJohnC.Hull201210
Terminology The party that has agreed to buy has what is termed a long position The party that has agreed to sell has what is termed a short position Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012 10