Thursday, January 25, 2007
The big big world of finance!!
This time, no more cribbing about IT industry :-) I have been fortunate enough to get work in the 'Investment Banking' domain..considered to be the hottest as far as the industry demands are concerned. With absolutely no prior knowledge of a single finance term I had to start with the basics..It was quite amusing to read about how people can make or break their future in a day..
Derivatives..had heard this term only in Maths till date but didn't know that it can be such a powerful instrument to make money..Its actually a financial contract whose value derives from the value of underlying stocks, bonds, currencies, commodities, etc..Derivatives can be either Forwards, Futures or Options..I found Options to be most interesting coz I never knew that we have a choice to go back on our deal if we see that we are not making any profit..but since nothing comes for free you have to pay a small premium for entering into the contract which is ALL that you lose when you want to go back on the trade. When I read this for the first time, the first thing that struck me was, why do people lose money if such a thing exists! Well, all of this is not so simple as it sounds. This is coz there are 2 kinds of people in the market: bearish and bullish..bearish believe that the prices of the underlying asset will fall and bullish think otherwise.
An option is a contract which confers the right, to buy or sell an asset at a given price on or before a given date. Here, the buyer of the option has the right whereas the seller has the obligation which means that the buyer can cancel the contract if he feels that he has not been able to make the expected profit till the due date. But if he wishes to settle the contract on the maturity date then the seller is obliged to respect the contract. Sounds confusing??? Lets consider the most basic example. A farmer expects to harvest wheat in 3 months. He expcts the wheat prices to drop from Rs 10 per kg due to over supply. So he enters into an options contract with a baker to sell wheat to him at Rs 10 per kg in 3 months. Baker expects the wheat prices to rise hence he agrees to buy it. If the wheat prices fall to 6 per kg, farmer benefits and the baker loses the opportunity to buy from the market at lower price. Whereas if the wheat prices rise to Rs 15 per kg , farmer still has the choice to cancel the contract. He has to pay the baker the premium amount though. Hence, the buyer of the option has the choice whereas the seller has the obligation.
Though derivatives are majorly used to hedge risks but there are speculators too, who enter into derivatives to make short term gains. There are many more interesting things about derivatives which had given me a kick when I had read them for the first time. For more information there is an amazing site http://investopedia.com/
Derivatives..had heard this term only in Maths till date but didn't know that it can be such a powerful instrument to make money..Its actually a financial contract whose value derives from the value of underlying stocks, bonds, currencies, commodities, etc..Derivatives can be either Forwards, Futures or Options..I found Options to be most interesting coz I never knew that we have a choice to go back on our deal if we see that we are not making any profit..but since nothing comes for free you have to pay a small premium for entering into the contract which is ALL that you lose when you want to go back on the trade. When I read this for the first time, the first thing that struck me was, why do people lose money if such a thing exists! Well, all of this is not so simple as it sounds. This is coz there are 2 kinds of people in the market: bearish and bullish..bearish believe that the prices of the underlying asset will fall and bullish think otherwise.
An option is a contract which confers the right, to buy or sell an asset at a given price on or before a given date. Here, the buyer of the option has the right whereas the seller has the obligation which means that the buyer can cancel the contract if he feels that he has not been able to make the expected profit till the due date. But if he wishes to settle the contract on the maturity date then the seller is obliged to respect the contract. Sounds confusing??? Lets consider the most basic example. A farmer expects to harvest wheat in 3 months. He expcts the wheat prices to drop from Rs 10 per kg due to over supply. So he enters into an options contract with a baker to sell wheat to him at Rs 10 per kg in 3 months. Baker expects the wheat prices to rise hence he agrees to buy it. If the wheat prices fall to 6 per kg, farmer benefits and the baker loses the opportunity to buy from the market at lower price. Whereas if the wheat prices rise to Rs 15 per kg , farmer still has the choice to cancel the contract. He has to pay the baker the premium amount though. Hence, the buyer of the option has the choice whereas the seller has the obligation.
Though derivatives are majorly used to hedge risks but there are speculators too, who enter into derivatives to make short term gains. There are many more interesting things about derivatives which had given me a kick when I had read them for the first time. For more information there is an amazing site http://investopedia.com/
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