Hello everyone: I have already finished all derivatives, (now i am going to practice)
But I have a question of a characteristic of a derivative.
The book basically says: a derivative TRANSFORMS the performance of the underlying while mutual funds just pass through the returns.
My question is: what do they mean by “transforms” and “pass through”?
Thanks in advance
The performance of a derivative is not the same as the performance of the underlying. For example, if you buy a call option, then your downside is limited to the premium, while your upside is unlimited; if you had bought the underlying you would potentially have a much greater downside. Therefore, the option (a derivative) has changed or transformed the performance of the underlying.
In contrast, if you buy a share in a mutual fund that owns that same underlying, you’re subject to exactly the same performance as if you had bought the underlying directly (apart from the management fee, of course): if the return on the underlying is 1%, your return is 1%; if the return on the underlying is −1%, your return is −1%.
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Ooh thanks, I did not understand it when I first read it
And for example with a long position on a forward contact, the difference is that on the spot market my gain would be: ST-S0 while on the future contract is: ST-F(0,T) ?
The primary difference between a forward contract and the underlying is that the forward contract requires no upfront cash, so the return has essentially infinite leverage.
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