Hi guys, was wondering if any of u smart peeps knows how derivatives are used as an investment vehicle as opposed to their normal use as a hedging instrument. Would appreciate any answers or ideas…cheers guys!
Easy. Go long an index future. You have a tracker. That is all.
Derivatives are normally used as a hedging vehicle?! Sure… In futures markets, for example, 95% of participants are speculators.
Did you read the news on how one trader screwed the bank in France?
banks hedge using caps/floors, for example if their deposit rates are very sensitive to a rise in 3 month LIBOR, they might buy a cap to hedge the increase in cost of funds from an inc in rates. example: deposit rate is 3%. this is a cost to the bank since they pay you interest for your money. if rates go up to 5%, then their cost of funds goes up to 5% as well. so they could buy a cap at 4% to offset this increase in cost of funds, where the cap pays them anything over 4%. thats just an example of a real life hedge with derivatives, although the majority of derivatives are used in speculation (see joey D’s msg above)
There are derivative products wherein an investor can enhance her yield (by incurring higher risk of course). A case in point is the first to default basket product. An fixed income investor whose benchmark allows him to buy certain credits can enhance his yield by selling protection on the basket of issuers of her choice. If any of the issuers in the basket defaults, you pay up face value of the defaulter’s issue. Ironically, this is the exact opposite of the first motive in portfolio mgmt : diversification. But then the guys peddling this product argue that you are exposed to the risk of default anyway !!! So why not take home the extra premium the market is offering!!! The additional risk doesnt show up on information ratios/past performances.
Look at any linked note product… equity, commodity, etc. Lots of derivatives masked as investment vehicles there.
Yes. It is simple. For example if you want to control 100 share of Google. You can buy a call with strike price 450 for example for just about 3800$ instead of $45,000 if you buy stock . http://finance.yahoo.com/q/op?s=GOOG&m=2008-06 Of course, you could lose it alll if your bet is wrong.