DerivativeinstrumentsA derivative instrument is afinancial contract whose payoff structure is determined by the value of theunderlying asset. The underlying asset can be commodity, security, interestrate, share price index, oil price, currency (exchange rate) in circulation,precious metals or the likeTypes of derivatives:1) forwardcontractsA forwardcontract obliges its purchaser to buy a given amount of a specified asset atsome stated time in the future at the forward price2) FuturecontractsFuturescontracts are created and traded on organized futures exchanges. . Buyers andsellers of future contracts do not deal directly with each other but with aclearinghouse3) optionsAn option isa derivative security that gives the buyer (holder) the right, but not theobligation, to buy or sell a specified quantity of a specified asset within aspecified time period4) swaps A swap is aderivative contract through which two parties exchange financial instruments.The two commonly used swaps are interest rate swaps andcurrency swaps. Financialinstruments in US The financialsystem of the United States of America (US) constitutes the banking system1 ,nonbank financial institutions2 and financial markets3 The US Congressintroduces legislation relating to financial services, and regulators at federaland state levels issue rules and regulations governing the practices of theindustry.Equities areshares that represent part ownership of a business enterprise.
There aredifferent types of equities, namely, stocks, preferred stocks and warrants.The USequities markets comprise several stock exchanges. The most important arelocated in New York City: the New York Stock Exchange (NYSE) and the AmericanStock Exchange (AMEX). Stocks not listed on a formal exchange are traded in theover-the-counter (OTC) market which includes the National Association ofSecurities Dealers Automated Quotation system (Nasdaq) and the National Marketsystem (NMS).
Securities markets are regulated by the Securities and ExchangeCommission (SEC).Debt MarketsBonds 5.11Bonds are debt securities with maturities of longer than one year and must beregistered with the SEC. The Securities and Exchange Commission (SEC) protectsinvestors and maintains the integrity of the securities markets. Bonds may be issued by governments or byprivate sector companies.Asset-backedSecurities Asset-backed securities are divided into twocategories, namely, mortgage-backed securities and non-mortgage securities.
Mortgage-backed securities give investors the right to interest payments from alarge number of mortgage loans. Examples of mortgage-backed securities areFannie Maes: 0 Fannie Maes are securities issued by the Federal NationalMortgage Association, a publicly owned, federally sponsored corporation thatprovides liquidity to the financial system by buying mortgages from theinstitutions that originate them, thus allowing them to relend the funds, Ginnie Maes:Ginnie Maes are securities issued by mortgage bankers, under the auspices ofthe Government National Mortgage Association, to facilitate government mortgagelending., FreddieMacs: 2 Freddie Macs are issued by the Federal Home Loan Mortgage Corporation(FHLMC). FHLMC packages the individual mortgages they buy into pools (groups ofsimilar types of mortgages with similar rates and maturities) and sell them toinvestors as debt securities and Farmer Macs: 3 Farmer Macs arepass-throughs of mortgages on farms and rural homes. The Federal AgriculturalMortgage Credit Corporation, a shareholder-owned company established by the USgovernment, securitizes both agricultural mortgages and loans guaranteed by theUS Department of Agriculture, some of which are not mortgages..Non-mortgage securities are asset backed securities which give owners the rightto income from other assets. Examples of non-mortgage securities are creditcard securities, home equity loans, automotive loans, manufactured-housingsecurities, student loans, stranded-cost securities and other novel types ofasset-backed securities.
There is no government regulator or SRO to regulatethe asset-backed securities industry. MunicipalSecurities 5.13 Municipal securities are debt securities such as bonds andnotes issued by states, cities and counties or their agencies to help financingpublic projects. Municipal securities are regulated by the Municipal SecuritiesRulemaking Board (MSRB).
Money marketinstruments:These are debtinstruments with maturities of one year or less and provide liquidity forinvestors to obtain or lend funds on a short-term basis. These instrumentsinclude commercial paper: short-term debt obligationof a private-sector firm or a governmentsponsored corporation. bankers’ acceptances: Bankers’ acceptances are promissory notesissued by a non-financial firm to bank for a loan. treasury bills: T-bills, are securities issuedby national governments with a maturity of one year or less. 27. 28.
30 governmentagency notes: Government agency notes are short-term debt notes issued bynational government agencies or government-sponsored corporations local government notes: Local government notesare short-term debt notes issued by state, provincial or local governments orby agencies of these governments interbank loans: Interbank loans are loans extended from onebank to another with which it has no affiliation. time deposits Time deposits areinterest-bearing bank deposits that cannot be withdrawn without penalty beforea specified date. They are also called certificates of deposit (CDS) international agency paper.
Futurecontracts t is an agreement to buy or sella standard amount of a specific commodity in the future at a certain price.There are two forms of future contracts, namely, commodity futures andfinancial futures Commodity futures concern agricultural products, metals,energy and transport. Financial futures include interest-rate futures, currencyfutures, stock-index futures, share-price futures, etc.optionsOptions are contracts that givethe holder the right, but not the obligation to either buy or sell a stipulatedcommodity at a specified price on or before the expiration date. The mostwidely traded types of options are equity options, index options, interest-rateoptions, commodity options and currency options.The Commodity Futures TradingCommission (CFTC) is an independent agency with the mandate to regulatecommodity futures and option markets in the US.