Derivatives

Flashcards about Derivatives and Hedging

Derivative

A financial instrument that derives its value from the movement in commodity prices, foreign exchange rate, and interest rate of an underlying asset or financial instrument.

Price risk

Uncertainty in the future price of an asset.

Credit risk

Uncertainty over whether a counterparty will honor the terms of the contract.

Interest rate risk

Uncertainty about future interest rates and their impact on cash flows and the fair value of financial instruments.

Foreign exchange risk

Uncertainty about future Philippine peso cash flows stemming from assets and liabilities denominated in foreign currency.

Underlying

A specified interest rate, commodity price, foreign exchange rate, index of prices or rates, and other variables that influence the value of a derivative.

Forward contract

A contract to purchase or sell a commodity at a designated future date at a predetermined price; a private, over-the-counter contract.

Futures contract

A contract to purchase or sell a commodity at a designated future date at a predetermined price; a standardized contract traded on an exchange market.

Option

A contract that gives the holder the right (not an obligation) to purchase an asset at a specified price within a given future time period.

Call option

Gives the holder the right to purchase an asset.

Put option

Gives the holder the right to sell an asset.

Interest rate swap (IRS)

A contract whereby two parties agree to exchange cash flows for future interest payments based on a contract of loan.

Hedging

Designating one or more hedging instruments so that their change in fair value is an offset to the change in fair value or cash flows of a hedged item.

Fair value hedge

Protection against the risk from changes in fair value caused by fixed terms, rates, or prices.

Cash flow hedge

Protection against the risk from changes in cash flows caused by variable terms, rates, or prices.

Hedge of a net investment in a foreign operation

Involves an underlying variable which is the foreign currency.