By Dimitris Chorafas

Written via a well known company monetary consultant, this well timed consultant deals a finished therapy of by-product monetary tools, totally overlaying bonds, curiosity swaps, recommendations, futures, foreign money, and extra. the writer explains the strategic use of derivatives, their position in portfolio administration, hedging, and the significance of coping with risk.

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Additional info for Introduction to Derivative Financial Instruments: Bonds, Swaps, Options, and Hedging

Sample text

A conservative policy will involve agreements on a one-to-one ship and FFA ratio as a way to either increase or decrease the firm’s exposure. Among issues to be kept in perspective are ● ● Counterparty risk The fact that FFAs are largely an unregulated market To solve the counterparty risk problem, there should be an indexing system in which parties are rated for their exposure in the FFA market, accounting for the fact that a major counterparty collapse could have a devastating domino effect on many other paper ship holders.

In all branches of finance, the major question to ask in terms of leveraging is on whose balance sheet this takes place: ● ● ● The shipowner The bank, or A special investment vehicle that lies between the bank and the shipowner A key challenge is that of precalculating life-cycle risk, which is a prerequisite to realistic pricing of the paper ship index. As with any instrument, the pricing affects the issuer, the buyer, and the market as a whole. Still another challenge is that of arriving at a factual and documented answer to the question of how far the paper ship index is effective in laying off risk.

It may be a number of shares, currency units, kilos, bushels, or other metrics underpinning the derivatives contract. The obligations of counterparties are established on the basis of this notional principal amount—a concept that applies to a wide range of instruments. Examples are ● ● ● Caps and floors Forward rate agreements All types of forward contracts for Treasury bonds, guilds, and bunds As these references suggest, the term notional is generic. The same is true with the term underlying in a derivatives transaction.

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