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Concept of forward/futures, call/put option, arbitrage,
hedging, speculation, collateral management?
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Answer Posted / kunal ingale
1. Forward:-
In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today.[1] This is in contrast to a spot contract, which is an agreement to buy or sell an asset today.
2. Futures:-
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today (the futures price or the strike price) with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange. The party agreeing to buy the underlying asset in the future, the "buyer" of the contract, is said to be "long", and the party agreeing to sell the asset in the future, the "seller" of the contract, is said to be "short".
3. Call/put option:-
Broadly speaking, options can be classified as ‘call’ options and ‘put’ options. When you buy a ‘call’ option, on a stock, you acquire a right to buy the stock. And when you buy a ‘put’ option, you acquire a right to sell the stock. You can also sell a ‘call’ option, in which, you will acquire an obligation to deliver the stock.
4. Arbitrage:-
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, it is the possibility of a risk-free profit at zero cost.
5. Hedging:-
Hedging means reducing or controlling risk. This is done by taking a position in the futures market that is opposite to the one in the physical market with the objective of reducing or limiting risks associated with price changes
Hedging is a two-step process. A gain or loss in the cash position due to changes in price levels will be countered by changes in the value of a futures position.
6. Speculation:-
Speculation is a financial action that does not promise safety of capital investment along with the return on the principal sum.[1] A person or entity that engages in speculation is known as a Speculator. Speculation typically involves the lending of money for the purchase of assets, equity or debt but in a manner that has not been given thorough analysis or is deemed to have low margin of safety or a significant risk of the loss of the principal investment.
7. Collateral management:-
Borrowing funds often requires the designation of collateral on the part of the recipient of the loan.
Collateral is legally watertight, valuable liquid property[3] that is pledged by the recipient as security on the value of the loan.
The main reason of taking collateral is credit risk reduction, especially during the time of the debt defaults, the currency crisis and the failure of major hedge funds. But there are many other motivations why parties take collateral from each other.
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