Week 11: Derivatives

What is hedging?

Making an investment to reduce the adverse price movements of an asset

Derivatives can be used to hedge what risks

Risks that companies encounter when they accept investment from investor or operate in financial markets - fluctuating financial prices

What is Speculation

Betting on the future movement’s of an asset’s price

In speculation,

1. if you guess correctly

2. If you guess incorrectly

1. You earn a profit

2. The loss goes against you

3 types of real options

1. Abandon 

2. Delay

3. Expand

Real options: Abandon

Option to stop a project if it becomes unprofitable

Real options: Expand

Option to increase investment and production if the project is successful

Real Options: Delay

Option to delay a project until more information becomes available

Real options is when

Business decisions are treated as financial options

In real options, businesses

have the right but not the obligation to take certain actions

What environments do real options add value to

Uncertain or volatile ones

What can be used in speculation?

1. Forwards

2. Futures

3. Swaps

4. Options