Date : 26.04.2016
After a very long time, I am writing this post...
Today's Agenda:
Topic - 1: Definition of Derivative
Topic - 2: OTC Markets
What is a Derivative?
If we google, we will get Text Book definition. Let us learn it in a different way.
The dictionary meaning of the derivative is "The Derived Value"...
If the value is derived, then from where it is derived? That is what we need to understand. For example, let us this example:
There are two friends Mr X and Mr Y. Mr X is holding 5000 water bottles. It is a very hot summer and Mr X knows that it is very difficult to get water bottles in the next 1 month in that area. Mr Y requires say around 1000 bottles of water bottles for some function in his house, which will take place after 1 month.
The discussion between Mr X and Mr Y is going like this...
Let us meet tomorrow....to know more...
For any queries...contact me at: cfa.surya@gmail.com
After a very long time, I am writing this post...
Today's Agenda:
Topic - 1: Definition of Derivative
Topic - 2: OTC Markets
What is a Derivative?
If we google, we will get Text Book definition. Let us learn it in a different way.
The dictionary meaning of the derivative is "The Derived Value"...
If the value is derived, then from where it is derived? That is what we need to understand. For example, let us this example:
There are two friends Mr X and Mr Y. Mr X is holding 5000 water bottles. It is a very hot summer and Mr X knows that it is very difficult to get water bottles in the next 1 month in that area. Mr Y requires say around 1000 bottles of water bottles for some function in his house, which will take place after 1 month.
The discussion between Mr X and Mr Y is going like this...
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Date of Discussion: 26.04.2016
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Mr Y
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Hey..I need 1000 bottles of water as on 27.05.2016. Can you please
provide?
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Mr X
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Yes. I can. But you need water bottles after 1 month…right?
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Mr Y
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Yes. But we can decide the price today itself?
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Mr X
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Oh! Okay…That is good. Today in the market one bottle cost is $2. How
much you are willing to pay as on 27.05.2016?
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Mr Y
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I can pay you around $2.25. Is it Okay?
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Mr X
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That is fine. So, I will have to supply 1000 bottles to you, each
bottle at $2.25. Right?
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Mr Y
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Yes Mr X. That is fine.
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Mr Y
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Shall we enter into an agreement for this selling and buying between
us?
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Mr X
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Yes…
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What do we understand?
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Contract Name
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Forward Contract
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Why
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It is a delivery of the content that is mentioned in the contract
will take place in future
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Is the contract entered through any Intermediary?
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No, It is a contract between two parties, over the counter
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OTC contract
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This is a contract entered between two parties, over a counter,
without involving any third party like Exchange
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Who will hold the contract
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Logically, the Buyer of the water bottles. That is Mr Y will hold.
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Can Mr Y sell this Forward contract to any other party?
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Yes. If someone wants to buy, he can sell. This means, the forward
contract changes hands. In that case, before the delivery of the 1000 bottles
of water, the forward contract also changes many hands. The instrument /
paper / contract, if it can be bought and sold, the instrument is tradable,
marketable and it has some price.
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What do we understand?
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The forward contract instrument / paper has its own price, apart from
the price of the water bottle price of $2.25
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What type of contract it is?
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It is an Over The Counter (OTC) contract.
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Quick trick to remember?
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There is no involvement of any guarantor or exchange between Mr X and
Mr Y for this forward contract.
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Let us meet tomorrow....to know more...
For any queries...contact me at: cfa.surya@gmail.com
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