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Banking & Finance Articles
Page 15 of 102
What are the differences between backwardation and contango?
The major differences between backwardation and contango are as follows −BackwardationIt refers to the prevailing conditions of the market, when future price of commodities (gold, silver etc.) trade lower than anticipated price.Usually takes place when value determined (spot price – futures price) is lower than cost of carrying.Spot price is higher when compared to forward price of future contract in a market normal backwardation.Forward price of the future contract is lower as compared to spot price in a market in normal backwardation.Convenience yield, oversupply of futures/spot etc. are reasons for backwardation.Forward price curve is sloping downward (inverted market).Occurs rarely.Results a ...
Read MoreWhat is a commodity future contract?
It is an agreement in which the seller will sell a predetermined amount of commodities to the buyer on a particular date at a specific price. The main difference from future contract and option contracts is that holder in future contracts has obligation to act. Commodity contracts include assets like crude oil, gold, silver, wheat, corn, natural gas etc.AdvantagesThe advantages of the commodity future contract are as follows −Seller receives fixed sales price.Since the buyers agree to take commodities at a particular rate, if there is any price drop, the seller does not lose.Limited risk for sellers.Better production plans.DisadvantagesThe disadvantages ...
Read MoreWhat is the total return swap (TRS)?
Total return swap (TRS) is an agreement between the two parties in which they exchange returns on financial assets. One party will pay on a set rate and the other will pay on the total return of the underlying asset (bond, loan, equity interest etc.). In this swap, the party receives an income without owning it.CharacteristicsThe characteristics of total return swap are as follows −Referenced asset.It clearly states what is included in the total return.Reference index.Spread included.Whether notional is fixed or notReceive or pay.Swap price.Effective date and maturity date.Payment frequency.TypesThe two types of TRS are as follows −Credit derivative − ...
Read MoreWhat is a credit default swap?
Credit default swap acts as the insurance policies. It is a financial derivative which allows an investor to offset their credit risk with that of other investors. In this swap, the buyer will pay quarterly installments to the seller. It protects against high-risk corporate debts, municipal bonds and sovereign bonds.It is an agreement between protection buyer and protection seller. In this, any loss of buyer from credit event (bankruptcy, restructuring etc.) in reference instrument is compensated by protection seller. In case of default, the seller will pay bond face value to the buyer.FormulaThe formula to calculate the credit default swap ...
Read MoreWhat is the concept of interest rate swaps?
Interest rate swap is an agreement between parties to exchange interest rates. Let’s say, we have two parties (first party and second party). Then, the most commonly used interest rate agreement is “first party agrees to pay at fixed interest rate to second party and second party agrees to pay at floating interest rate to first party”. Mostly banks, corporations and investors use interest rate swaps.Reasons to useThe reasons to use the interest swap rates are explained below −Offset risk of floating interest rate.To lock the future fixed rate.Leverage rate between the currencies.To speculate on the predicated fluctuation rates.TypesThe two ...
Read MoreWhat is the currency futures?
Currency futures is a type of contract in which two sides agree to exchange a specific quantity of a particular currency on a specific date at a pre agreed price. These are legally binding agreements and on expiry date, counter parties will have to deliver the amount on a delivery date at pre agreed price. They can also be used to hedge the currency risks or price speculations.Specifications of currency futures are as follows −Parties to the contract.Size of contract.Position limitations.Spot and future prices.Margins requirements (initial, maintenance, variations margins).Market to market.Formula to calculate the currency future is given below −Currency ...
Read MoreWhat is future contract?
A future contract is the contract between a buyer and a seller, where the buyer agrees to buy a particular asset at a predetermined price. Buyer in the future contract will hold a long position and the seller will have a short position.Future contracts allow companies to hedge their risk associated with the interest rates, exchange rates and business risk with commodity prices. Future contract helps investors to obtain exposure to a stock or a bond or a market (stock) index or any other financial assets.FeaturesThe features of future contract are as follows −Organised exchanges − These are traded in ...
Read MoreWhat is the hedge ratio? Explain its advantages and disadvantages.
Hedge ratio is a ratio of value of hedge position to the value of total exposure. Value of hedge position is the total amount invested by investors in hedged position and value of total exposure is total amount invested by investor in underlying assets.Hedge ratio also can be a comparative value of future contracts, which are sold or purchased with change in value of cash commodity that are being hedged. Hedge ratio is expressed in decimal or fraction. If value is zero means, position is not at all hedged, similarly, if the value is one means, position is fully hedged.Investor ...
Read MoreWhat is hedge accounting?
In this method, companies are allowed to recognize their gains and losses on hedging instruments against exposure of derivative instruments to reduce income volatility, if both are accounted separately.The main purpose of hedge accounting is to match the derivative gain/loss with underlying investment gain/loss. Its main advantage is that it can recognize both the transactions in the same accounting period.Hedge accounting International Financial Reporting Standards (IFRS) 9 contains the following −Classification and measurement of financial instruments.Impairment of financial assets.TypesThe types of hedge accounting are as follows −Fair value hedge − Change in fair value of asset/liability/unrecognised firm commitment.Cash flow hedge ...
Read MoreWhat is the concept of hedging?
Hedging is designed to protect the share value from market volatility. In simple words, it acts like an insurance coverage which protects you from any potential loss.The main purpose of hedging is to minimise/eliminate risk by offsetting the potential losses. Investors follow this to safeguard their investments from losses due to market volatility. Hedging is also done in areas like commodities, securities, currencies etc.TypesThe types of hedging include −Forward contractsFuture contractsMoney marketsStrategiesThe various strategies to mitigate losses are as follows −Asset allocation − Portfolio diversification.Structure − Some part is invested in portfolio and some in derivatives.Through options − Options of ...
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