Different types of derivatives have different pricing mechanisms. A derivative is simply a financial contract with a value that is based on some 澳洲幸运5开奖号码历史查询:underlying asset (e.g. the price of a stock, bond, or commodity). The most common derivative types are futures contracts, 澳洲幸运5开奖号码历史查询:forward contracts, options and swaps. More🌜 exotic derivatives can be based on factors such as weather or carbon emissions.

Futures Pricing Basics

澳洲幸运5开奖号码历史查询:Futures contracts are standardized financial contracts that allow holders to buy or sell an underlying asset or 澳洲幸运5开奖号码历史查询:commodity at a certain price in the future, which is locked in today. Therefore, the futures contract's value is based on the commodity's 澳洲幸运5开奖号码历史查询:cash price.

Futures prices will often deviate somewhat from the cash, or spot price, of the underlying. The difference between the cash price of the commodity and the futures price is the basis. It is a crucial concept for portfolio managers and traders because this relationship between cash and👍 futures prices affects the value of the contracts used in hedging. As there are gaps between spot and relatꦅive price until expiry of the nearest contract, the basis is not necessarily accurate.

In addition to the deviations created because of the time gap between expiry of the futures contract and the spot commodity, product quality, location of deli🍒very and the actuals may also vary. In general, the basis is used by investors to gauge the profitability of delivery of cash or the actual, and is also used to search for arbitrage opportunities.

For example, consider a corn futures contract that represents 5,000 bushels of corn. If corn is trading at $5 per bushel, the value of the contract is $25,000. Futures contracts are standardized to include a certain amount and quality of the underlying commodity, so they can be traded on a centralized exchange. The futures price moves in relation to the 澳洲幸运5开奖号码历史查询:spot price for the commodity based on 澳洲幸运5开奖号码历史查询:supply and demand for that commodity.

Forwards are priced similarly to futures, but forwards are non-standardized contracts that arran🤡ged instead between two counterparties and t🍬ransacted over-the-counter with more flexibility of terms.

Options Pricing Basics

Options are also common derivative contracts. Options give the buyer the right, but not the obligation, to buy or sell a set amount of the underlying asset at a pre-determined price, known as the 澳洲幸运5开奖号码历史查询:strike price, before the contract expires.

The primary goal of option pricing theory is to calculate the probability that an option will be exercised, or be 澳洲幸运5开奖号码历史查询:in-the-money (ITM), at expiration. Underlying asset price (澳洲幸运5开奖号码历史查询:stock price), 澳洲幸运5开奖号码历史查询:exercise price, 澳洲幸运5开奖号码历史查询:volatility, 澳洲幸运5开奖号码历史查询:interest rate, and time to expirati🃏on, which is the number of days between the calculation date and the option's exercise date, are commonly used variables that are input into math𒆙ematical models to derive an option's theoretical fair value.

Aside from a company's stock and strike prices, time, volatility, and interest rates are also quite integral in accurately pricing an option. The longer that an investor has to exercise the option, the greater the likelihood that it will be ITM at expiration. Similarly, the more volatile the underlying asset, the greater the odds that it will expire ITM. High𝕴er interest rates should translate into higher option prices.

The best-known pricing model for options is the 澳洲幸运5开奖号码历史查询:Black-Scholes method. This method considers the underlying stock price, option 澳洲幸运5开奖号码历史查询:strike price, time until the option expires, underlying stock 澳洲幸运5开奖号码历史查询:volatility and risk-free 澳洲幸运5开奖号码历史查询:interest rate to provide a value for the option. Other popular models exist such as the 澳洲幸运5开奖号码历史查询:binomial tree and 澳洲幸运5开奖号码历史查询:trinomial tree pricing models.

Swaps Pricing Basics

Swaps are derivative instruments that represent an agreement between two parties to exchange a series of 澳洲幸运5开奖号码历史查询:cash flows over a specific period of time. Swaps offer great flexibility in designing and structuring contracts based on mutual agreement. This flexibility generates many swap variations, with each serving a specific purpose. For instance, one party may swap a fixed cash flow to receive a variables ca✤sh flow that fluctuates as interest rates change. Others may swap cash flows associ𒆙ated with the interest rates in one country for that of another.

The most basic type of swap is a 澳洲幸运5开奖号码历史查询:plain vanilla interest rate swap. In this type of swap, parties agree to exchange interest payments. For example, assume Bank A agrees to make payments to Bank B based on a fixed interest rate while Bank B agrees to make payments to Bank A based on a floating🐭 interes♕t rate.

The value of the swap at the initiation date will be zero to both parties. For this statement to be true, the values of the cash flow streams that the swap parties are going to exchange should be equal. This concept is illustrated with a hypothetical example in which the value of the fixed leg and floating leg of the swap will be V_fix and V_fl respectively. Thus, at initiation:

 $V_{fix} = V_{fl}$Vfix​=Vfl​

Notional amounts are not exchanged in interest rate swaps because these amounts are equal and it does not make sense to exchange them. If it is assumed that parties also decide to exchange the notional amount at the end of the period, the process will be similar to an exchange of a 澳洲幸运5开奖号码历史查询:fixed rate bond to a 澳洲幸运5开奖号码历史查询:floating rate bond with the same notional amount. Therefore such swap contractꦰs can be valued in terms of fixed and floating-rate bonds.