demystifying derivatives warren edwardes [email protected] 1 demystifying derivatives warren edwardes...
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1Demystifying DerivativesWarren Edwardes [email protected]
Demystifying Derivatives
Warren Edwardes
ceo, Delphi Risk Management Limited
2Demystifying DerivativesWarren Edwardes [email protected]
Author of
• Key financial instruments: – understanding and innovating in the world of
derivatives
3Demystifying DerivativesWarren Edwardes [email protected]
Famous cases:
• Barings – founded in 1763
– crashed through lack of control of derivatives
4Demystifying DerivativesWarren Edwardes [email protected]
Famous cases:
• Equitable Life– founded in 1762
– crashed through not using derivatives to manage interest rate risk
– boards have been successfully sued for not using derivatives to manage risk
5Demystifying DerivativesWarren Edwardes [email protected]
So what’s a derivative?
• a financial market derivative instrument is derived from other cash market instruments or other derivatives.
• the majority of financial instruments are not new instruments.
• They are merely combinations of derivatives and/or standard cash market instruments
• the building block approach
6Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - commodities
• orange juice futures
7Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - commodities
• Oil
• futures have liquid trading
• homogenous product
8Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - commodities
• Coffee
• a liquid market
• fairly standardised
9Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - commodities
• wine ??
• Not homogeneous
• not customer needs driven
• Paris market unlikely to survive
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Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - commodities
• property / real estate ??
• Not homogeneous
• FOX property market failed in 1991
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Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - shares?
• A share is an option on the assets of a firm
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Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - retail financial products
• foreign exchange notes
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Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - retail financial products
• fixed rate mortgages
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Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - retail financial products
• equity index linked savings
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Demystifying DerivativesWarren Edwardes [email protected]
Examples of derivatives - retail financial products
• Insurance?
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Demystifying DerivativesWarren Edwardes [email protected]
4 key financial building blocks
• spot– the now contract - like exchanging
Pounds for Pesetas in the high street
• forward– you could buy your Euros in the forward
market; payment and delivery next year.
• deposit– you could borrow money, buy the Euros
now (spot) and deposit the Euros.
• option– Equitable Life gave interest rate
guarantees - but didn’t manage the risk!
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Demystifying DerivativesWarren Edwardes [email protected]
Conclusion: what’s a derivative?
• a financial market derivative instrument is derived from other cash market instruments or other derivatives.
• the majority of financial instruments are not new instruments.
• They are merely combinations of derivatives and/or standard cash market instruments
• remember the building block approach
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Demystifying DerivativesWarren Edwardes [email protected]
And finally!
• Beware of insider trading
• underlying price manipulation– credit derivatives
• terrorists selling put options on American Airlines!
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Demystifying DerivativesWarren Edwardes [email protected]
Demystifying derivatives by Warren Edwardes