Example Derivatives provide insurance You earn $1 if your family s corn sells for a low price this supplement your Income Your friend earns $1 if the corn his family bought is expensive this offset the high cost of corn Charles cao 6
Charles Cao 6 Example ◼ Derivatives provide insurance ◼ You earn $1 if your family’s corn sells for a low price; this supplement your income ◼ Your friend earns $1 if the corn his family bought is expensive; this offset the high cost of corn
What is a derivative? Derivatives can be thought of as bets But the bet hedges you both against unfavorable outcomes The contracts has reduced risk for both of you Investors can use derivatives to speculate on the price of corn Key point: how it is used Charles cao
Charles Cao 7 What is a Derivative? ◼ Derivatives can be thought of as bets ◼ But the bet hedges you both against unfavorable outcomes ◼ The contracts has reduced risk for both of you ◼ Investors can use derivatives to speculate on the price of corn ◼ Key point: how it is used
Use of derivatives ■ Risk management Derivatives can be used to reduce risks Hedging Insurance(auto insurance) a speculation Derivatives can serve as investment vehicles Making bets highly leveraged Charles cao
Charles Cao 8 Use of Derivatives ◼ Risk management ◼ Derivatives can be used to reduce risks ◼ Hedging ◼ Insurance (auto insurance) ◼ Speculation ◼ Derivatives can serve as investment vehicles ◼ Making bets highly leveraged
Use of derivatives Reduced transaction costs a Low-cost way to effect a transaction Mutual-fund mangers wish to sell stocks and buy bonds Paying fees and trading costs Futures contracts have low costs Charles cao
Charles Cao 9 Use of Derivatives ◼ Reduced transaction costs ◼ Low-cost way to effect a transaction ◼ Mutual-fund mangers wish to sell stocks and buy bonds ◼ Paying fees and trading costs ◼ Futures contracts have low costs