Futures / Forward contracts are agreements to buy and sell (one party will buy and another will sell) an asset at a pre-determined price on a fixed future date. Agreements transacted through an exchange are called Futures contracts whereas agreements between two parties, that is a buyer and a seller, without the intervention of an exchange are known as Forward contracts.
Option contract is a right that the option buyer gets from the option seller also called the option writer to buy or sell an asset at a pre-determined price called the strike price during or at a particular time in future. Thus, the option buyer gets a right to buy or sell depending on the contract. Option contract that gives the right to buy an asset is known as call option; the contract that gives the right to sell an asset is called as put option. The option buyer purchases the right from the option writer by paying a price to the writer. This price is called the premium of the option. The day on which the option contract expires is called expiration day of the option. If the right to buy or sell can be exercised only on the expiration day, such an option is termed as 'European option'. If the right is exercisable on any day upto the expiration day, the option is called as 'American option'. So, the option buyer gets a wider window of time to exercise his / her option under American option.. Therefore, it stands to reason that American options attract higher premiums. In the Indian stock markets, only European options are allowed. Exercise day is the day on which the option is exercised. In case options are not exercised (this happens when the price movement is not favourable to the option buyer or the option holder), exercise day does not arise.
Swaps*
Another important class of derivative security are swaps, perhaps the most common of which are interest rate swaps and currency swaps. Other types of swaps include equity and commodity swaps. A plain vanilla swap usually involves one party swapping a series of fixed level payments for a series of variable payments.
Swaps were introduced primarily for their use in risk-management. For example, it is often the case that a party faces a stream of obligations that are floating or stochastic, but that it will have to meet these obligations with a stream of fixed payments. Because of this mismatch between floating and fixed, there is no guarantee that the party will be able to meet its obligations. However, if the present value of the fixed stream is greater than or equal to the present value of the floating stream, then it could purchase an appropriate swap and thereby ensure that it can meet its obligations. (*Acknowledgement: Description of Swaps is taken from www.columbia.edu IEOR E4706: Financial Engineering: Discrete-Time Models °c 2010 by Martin Haugh)
Option contract is a right that the option buyer gets from the option seller also called the option writer to buy or sell an asset at a pre-determined price called the strike price during or at a particular time in future. Thus, the option buyer gets a right to buy or sell depending on the contract. Option contract that gives the right to buy an asset is known as call option; the contract that gives the right to sell an asset is called as put option. The option buyer purchases the right from the option writer by paying a price to the writer. This price is called the premium of the option. The day on which the option contract expires is called expiration day of the option. If the right to buy or sell can be exercised only on the expiration day, such an option is termed as 'European option'. If the right is exercisable on any day upto the expiration day, the option is called as 'American option'. So, the option buyer gets a wider window of time to exercise his / her option under American option.. Therefore, it stands to reason that American options attract higher premiums. In the Indian stock markets, only European options are allowed. Exercise day is the day on which the option is exercised. In case options are not exercised (this happens when the price movement is not favourable to the option buyer or the option holder), exercise day does not arise.
Swaps*
Another important class of derivative security are swaps, perhaps the most common of which are interest rate swaps and currency swaps. Other types of swaps include equity and commodity swaps. A plain vanilla swap usually involves one party swapping a series of fixed level payments for a series of variable payments.
Swaps were introduced primarily for their use in risk-management. For example, it is often the case that a party faces a stream of obligations that are floating or stochastic, but that it will have to meet these obligations with a stream of fixed payments. Because of this mismatch between floating and fixed, there is no guarantee that the party will be able to meet its obligations. However, if the present value of the fixed stream is greater than or equal to the present value of the floating stream, then it could purchase an appropriate swap and thereby ensure that it can meet its obligations. (*Acknowledgement: Description of Swaps is taken from www.columbia.edu IEOR E4706: Financial Engineering: Discrete-Time Models °c 2010 by Martin Haugh)
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