1. What is a derivative instrument? 2. What are the two categories of derivative
ID: 2817084 • Letter: 1
Question
1. What is a derivative instrument? 2. What are the two categories of derivatives? 3. What did warren buffet associate the derivatives market with? 4. What is a call option? 5. What is an out of the money option? 6. What is a risk associated with forward contracts? 7. What is the difference between hedgers and speculators? 8. How can a US company expected to pay 1 million euros in 6 months protect itself from fluctuations in exchange rates? 9. How is a forward contract settled? 10. Give two examples of the possible underlying assets for derivatives?
Explanation / Answer
Ans 1) Derivative is actually nothing but a financial instrument, wherein its value is basically derived from its underlying entity, it can be either assets,shares, interest. The most common examples for derivatives would be Options, Futures, Forwards.
Ans 2) Two categories of derivatives would ascertained on the basis of its tradability. Derivatives can be categorised the way they get traded. Derivatives are traded either over the counter (OTC) or through exchange, hence two categories of derivatives would OTC derivatives and Exchange derivatives.
Ans 3) Warren Buffet could be associated with derivatives market like the one who traded and used the derivatives to make huge profits for its company Berkshire Hathway. Also Warrent Buffet mentions that derivative is a weapon of mass destruction because it is very difficult for common investors to understand and lack of proper financial regulations.
Ans 4) Call option is actually nothing but a derivatives instrument which actually gives the right to its buyer to buy underlying assets that could be shares, stocks, bonds and commodity at as specified date and at a specified price. It does not give any obligation to option buyer to buy the assets, he may choose buy or not.
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