Thursday, November 25, 2010

DERIVATTIVES / DERIVATIVE INSTRUMENTS.

DERIVATTIVES / DERIVATIVE INSTRUMENTS.
A derivattives is an instrument , value of which is derived from the value of another investment / asset.Called a underliying asset or security. A brief description on derivattives are given below;

(1)-Forward Contracts.
A forward contract is an agreement made between two parties to exchange an asset at a specified price at a specified date. Because it is a contract , the buyer is obliged to purchase the asset the seller is obliged to sell at the predetermined price ( the exercise price ) on the specified date ( the expiration date ).

•The buyer of a future enters into an obligations to buy on a specified date.
•The seller of a future is under an onligation to sell on a future date.

These obligations relate to a standard quantity of a specified asset on a fixed future date at a price agreed today.
Types of Futures
(1). Commodity futures,
Based on underline commodities & could be used to hedge an underline commodity position or to speculate on the commodity.
(2). Index Futures,

Based on stock indexes.
(3). Interest Rate Futures.
Based on movement in interest rates & could be used to hedge diposits or borrowings or speculate on interest rate movements.
(4). Currency Futures.
Based on foreign exchange rates between two specified currencies & could be used to hedge underlying currency positions or to speculate on currency movements.
(3)-Options.
An option is a contract that confers upon the buyer the right , but not the obligation, to buy or sell an asset at a given price on or before a given date. All the comments related to standard quantities , specified assets , fixed future dates & price agreed today that we noted for futures still apply for options as well.

In the definition above , on option was discribed as being the right , but not the obligation to buy or sell. The right to buy & the right to sell are given different names, as follows ,

•The right to buy is known as a call option.
•The right to sell is known as a put option.

(4)-Swaps.
A swap is a contractual agreement evidenced by a single document in which two parties. Called counter parties, agree to make periodic payments to each other.In other words , it is the transformation of one stream of future cash flows with another stream of future cash flows with different features.

Swaps have become one of the most important & flexible instruments available to banks & corporate treasurers for asset & liability management.Like other hedging & treasury management models, swaps themselves are not instruments for rising new funds. They are transacted to make new or existing cash flows more attractive, Swaps are often combined with bond issues to achieve particularly favorable funding costs. They also allow a borrower , unable to raise funds efficiently in the bond markets , acces to fixed rate finance. For banks, the swap market provibes a means of laying off risk when they are providing clients with medium-term fixed rate loans. Bank can also make profits from trading swaps.

Sunday, November 14, 2010

EFFICIENT CAPITAL MARKET of EMH & ( Efficient Market Hypothesis ).

Efficient Market & EMH.
In an efficient capital market, security prices adjust rapidly to the infusion of new information. And therefore current security prices fully reflect all available information. This is to as an informationally efficient market.

Why Capital Markets Should Be Efficient ?

Following set of assumptions imply an efficient capital market:
1 .A large no of profit maximizing participants analyze & value securities, each independent of others.
2 .New information regarding securities comes to the market in a random fashion, & timing of one announcement is generally independent of others.
3 .Profit maximizing investors adjust security prices rapidly to reflect the effect of new information.
4 .Because security prices adjust to all new information, these security prices should reflect all information that is publicly available at any point in time.

Efficient Market Hypothesis (EMH).
The three (3) forms of efficient market hypotheses are:

1. Weak for EMH.-----The week for EMH assumes that current stock prices fully reflect all security market information. Including the historical sequence of prices rates of return trading volume data & other market generated information. This hypothesis implies that past rates of return & other market data have no relationship with future rates of return.
2. Semi Strong Form EMH.-----This assets that security prices adjust rapidly to the release of all public information; that is, current security prices fully reflect all public information, The semi strong for EMH encompasses the weak form hypothesis, because all the market information considered by the weak form hypothesis, such as stock prices, rates of return , trading volume is public. Public information also includes all non-market information such as earnings & dividend announcements price earnings ratio, dividend yields,book value etc. This hypothesis implies that investors who base their decisions on any important new information after it is public should not derive above average risk adjusted profits from their transactions, because the security price already reflects all such new public information.
3. Strong Form EMH.-----The strong form EMH contends that stock prices fully reflect all information public & private sources. This means that no group of investors has monopolistic access to information relevant to the information of prices.Therefore this hypothesis contends that no group of investors should be able to consistently drive above avarage risk adjusted rates of return.This hypothesis encompasses both the wake form & semi strong form EMH.Further , the strong form EMH extends the assumption of efficient markets, in which prices adjust rapidly to the release of new public information to assume perfect markets , in which all information is cost free & available to everyone at the sometime.