INDIVIDUAL ASSIGNMENT CHAPTER 5
1. Why do investors use derivative securities in financial market?
Manage risk: Protect the value of investments from adverse fluctuations.
Expect profit: Increase profit potential through leverage.
Access markets: Invest in markets that are difficult to access directly.
Transaction efficiency: Save costs and implement more complex strategies.
2. Differentiate between a forward contract and a futures contract.
Standardization:
Forward Contracts: Are non-standardized agreements. The terms of the contract, including the quantity
of the asset, quality, delivery date, and delivery location, are customized to suit the specific needs of
the two parties involved.
Futures Contracts: Are standardized contracts. The terms of the contract are fixed by the exchange,
such as the contract size, grade of the asset, and specific delivery months.
Trading Venue:
Forward Contracts: Are typically traded in the Over-the-Counter (OTC) market, directly between two
parties or through a dealer.
Futures Contracts: Are bought and sold on organized exchanges (e.g., the Hanoi Stock Exchange
(HNX) for some derivatives, or specialized commodity exchanges globally).
Regulation and Supervision:
Forward Contracts: Are less regulated, primarily governed by contract law between the parties.
Futures Contracts: Are subject to strict supervision by the exchange and regulatory bodies to ensure
fair trading and prevent market manipulation.
Counterparty Risk:
Forward Contracts: Carry higher counterparty risk, which is the risk that one of the two parties will fail
to fulfill their obligations when the contract matures.
Futures Contracts: Have lower counterparty risk because the exchange acts as a clearinghouse,
guaranteeing the performance of both sides of the contract through a clearing mechanism.
5. Margin Requirements:
Forward Contracts: Typically do not require an initial margin, but the entire contract value is at risk.
Futures Contracts: Require an initial margin (a deposit) and may require additional maintenance
margin to cover potential daily losses.
6. Daily Settlement (Mark-to-Market):
Forward Contracts: Do not have daily settlement. Gains or losses are only realized when the contract
matures.
Futures Contracts: Are marked-to-market daily. The contract is revalued based on the closing price
each day, and any profits or losses are credited or debited to the margin account daily.
3. What are the call option and put option?
Call Option: A contract that gives the buyer the right (but not the obligation) to buy an
underlying asset at a predetermined strike price within a specific period. The buyer of a
call option expects the market price to increase in the future.
Put Option: A contract that gives the buyer the right (but not the obligation) to sell an
underlying asset at the strike price within the contract period. The buyer of a put option
expects the market price to decrease.
Analyze the profit (gain/loss) when exercising call and put options
For Call Option Buyers
Profit: When the asset price rises above the strike price plus the option premium, the buyer
can buy low – sell high and earn a profit.
Maximum Loss: If the price doesn't rise as expected, the buyer only loses the premium paid.
Ex: You pay 10,000 VND to buy the right to purchase stock ABC at 100,000 VND. If, at
expiration, the market price rises to 120,000 VND, you can buy at 100,000 VND and sell at
120,000 VND, making a profit of 20,000 – 10,000 = 10,000 VND.
For Put Option Buyers
Profit: When the asset price falls below the strike price minus the premium, the buyer can
sell high – buy low and earn a profit.
Maximum Loss: If the price doesn't fall as expected, the buyer only loses the premium paid.
Ex: You buy the right to sell stock DEF at 100,000 VND, paying a 10,000 VND premium. If
the stock price drops to 80,000 VND, you still have the right to sell it at 100,000 VND → profit
is 20,000 – 10,000 = 10,000 VND.
Option Type Market Expectation Maximum Profit Maximum Loss
Call Option Price will increase Unlimited Premium paid
Put Option Price will decrease Almost strike price Premium paid
4. Why do investors use swap contracts for hedging and speculation?
What Is a Swap Contract?
A swap is a financial agreement between two parties to exchange cash flows over time, based on
different financial instruments (e.g., interest rates, currencies, commodities). The two most common
types are:
Interest Rate Swaps
Currency Swaps
1. Why Do Investors Use Swaps for Hedging?
➤ Purpose: Reduce risk caused by market fluctuations.
How It Works:
Swaps help investors or companies lock in predictable cash flows and protect themselves from:
Interest rate risk (fluctuations in variable/fixed rates)
Currency risk (fluctuations in exchange rates)
Commodity price risk (for producers and consumers of raw materials)
Ex– Interest Rate Swap for Hedging:
A company has a loan with variable interest, but fears that interest rates will rise. It enters an interest
rate swap to pay fixed interest and receive variable. This hedges against the risk of rising rates.
Ex – Currency Swap for Hedging:
A Vietnamese company earns revenue in USD but has to pay debts in VND. They enter a currency
swap to convert USD into VND at a fixed rate regularly — this protects against exchange rate
volatility.
2. Why Do Investors Use Swaps for Speculation?
➤ Purpose: Profit from expected changes in rates or prices.
How It Works:
Speculators use swaps to bet on market movements — without owning the underlying assets — and
make gains if their predictions are correct.
Ex – Interest Rate Swap for Speculation:
A hedge fund expects interest rates to drop. They enter a swap to receive fixed and pay floating. If
rates do fall, the floating payments are lower, and they profit from the difference.
Ex– Currency Swap for Speculation:
A trader predicts the USD will strengthen against the EUR. By entering a currency swap, they can
gain if the exchange rate moves as expected.
Purpose How Swaps Are Used Benefit
Protect against interest rate,
Hedging Stable cash flow, reduced uncertainty
currency, or price risks
Bet on market trends
Speculation Potential profit from market movements
without owning assets
