789

Derivatives - the basics

Head of Foreign Exchange and Emerging Markets Quant at Morgan Stanley, explains derivatives
Investment banking
Types of work

University College London****recently held its inaugural Financial Markets Conference. It was organised by a team from the university's Augustus De Morgan Maths Society. Over 150 students came to watch presentations from senior representatives from some of the world's largest financial institutions. The idea was to give an insight into the various products and roles that make up the financial markets. In this extract from his presentation Dr. Jamie Walton, Head of Foreign Exchange and Emerging Markets Quant at Morgan Stanley, explains what a derivative is.

The main asset classes are equities, interest rates, foreign exchange, commodities and credit.

A derivative is any product whose value is dependent on one or more underlying asset. Two common types of derivatives are forwards and options.

A forward allows you to buy or sell an underlying asset at a future date at a level determined today.

Futures are similar to forwards except that they are traded on exchanges (forwards are traded over the counter) and an investor needs to post margins regularly.

An option is the right to buy or sell the underlying asset at a fixed price on a given future date. An option to buy the underlying asset is called a call option and the option to sell it is called a put option. As the option is a right and not an obligation, it is only exercised if it has positive value (we say it is "in-the-money").

Hedging is a strategy in which by use of derivatives a party can reduce its risk. An investor engages in transactions that will counterbalance his position on another trade, thus ensuring a certain profit or minimising losses.

Speculation: Derivatives can also be used to increase risk and generate higher returns. An investor may choose to buy or sell derivatives depending upon whether they expect the value of the underlying asset to rise or fall. This involves speculating on the future movement of markets. Speculation is a popular strategy because the profits can be greater and the losses more limited than if the investor held the asset itself.

Arbitrage: An arbitrage opportunity exists where there is a discrepancy in the markets, which means the investor has the chance to make a profit but is guaranteed not to make a loss. There might be a discrepancy between the current value of an asset and its true value. If a market has a significant number of players (i.e. is highly liquid), then such opportunities cease to exist as the present value is pushed towards the true value of the asset.


Continue learning below

What is your Self-awareness score?
Take the test

Click an answer below to begin the test

I often reflect on my thoughts

< Strongly Disagree
Strongly Agree >

I do not often think about the way I am feeling

< Strongly Disagree
Strongly Agree >

I enjoy exploring my “inner self"

< Strongly Disagree
Strongly Agree >

I often reflect on my feelings

< Strongly Disagree
Strongly Agree >

Others would benefit from reflecting more on their thoughts

< Strongly Disagree
Strongly Agree >

I am interested in analysing the behaviour of others

< Strongly Disagree
Strongly Agree >

I value opportunities to evaluate my behaviour

< Strongly Disagree
Strongly Agree >

It is important to understand why people behave in the way they do

< Strongly Disagree
Strongly Agree >

When I’m feeling uncomfortable, I can easily name these feelings

< Strongly Disagree
Strongly Agree >

I usually know why I am feeling the way I do

< Strongly Disagree
Strongly Agree >

I am often on auto-pilot and do not pay much attention to what I am doing

< Strongly Disagree
Strongly Agree >

Sometimes I am careless because I am preoccupied, with many things on my mind

< Strongly Disagree
Strongly Agree >

I often dwell on the past or the future, rather than the present

< Strongly Disagree
Strongly Agree >

My mind often wanders when I am trying to concentrate

< Strongly Disagree
Strongly Agree >

I often find myself thinking about how to solve past negative events

< Strongly Disagree
Strongly Agree >

When things go wrong, I often think about them constructively for long periods of time

< Strongly Disagree
Strongly Agree >

I tend not to look back and think about how I could have done things better

< Strongly Disagree
Strongly Agree >

Add your email

What company do you work for?

What would help you increase your current salary?

Your personal development is important to us, by clicking "Submit Answers” you agree to Weavee's Terms, Conditions and Privacy Policy