Financial Derivatives
Financial Derivatives
i. Forward Contract
ii. Future Contract
iii. Option Contract
1. Forward Contract: You have the obligation to buy or sell an instrument at a prespecified price
at a prespecified maturity date.
Example-1: A has entered into a contract with B to buy 100 shares of ABC limited from B at $10 per
share on December 31, 2025.
At December 31, 2025, the actual market (spot) price of the share is $12 per share.
Here, A can buy the shares from B at $10 per share with a total amount of $1000 (100*`10).
Or, A can take (if the contract suggests) $200 from B, which is the net amount of profit A is going to make
from this deal.
Example-2: C has entered into a contract to buy a machinery from XYZ company in USA at $1000, which
is payable at 31 December 2025. C is speculating that the USD price might increase in terms of BDT, and
considering hedging his payable position against this uncertainty. So, C enters into a contract with D to
buy $1000 at 31 December 2025, at BDT100/USD.
Either, C can buy $1000 at BDT 100/usd from D, totaling BDT 100,000.
In each case, C can pay the payable to XYZ of $1000 by spending the same amount of BDT 100,000.
In an Alternate scenario:
Either, C can buy $1000 at BDT 100/usd from D, totaling BDT 100,000.
In each case, C can pay the payable to XYZ of $1000 by spending the same amount of BDT 100,000.
2. Future Contract: You have the obligation to buy or sell an instrument at a prespecified price at
a prespecified maturity date.
Actual market and future market are completely different. One can enter into a transaction in the
actual market and can simultaneously enter into a transaction on the same asset on future market.
At 30 June 2025, the rate falls to Now, A buys USD future at a net cost:
0.0082-0.0083/BDT (Direct quote: 120.48- $200/0.0084 = 23,800
121.95/USD).
You Expect to receive 500 pounds from an UK The available future contracts for pounds are
importer at 31 July 2025. The spot rate today for trading at 0.0076-0.0077/BDT.
Pounds: 0.0075-0.0076/BDT.
At 31 July 2025, the spot rates are noted for At 31 July 2025, the spot rates for future are
pounds at: 0.0078-0.0079/BDT noted at 0.0079-0.0080
3. Options Contracts: You have the obligation right to buy or sell an instrument at a prespecified
price at a prespecified maturity date.
There are two types of options contract: Call option and Put option
i. Call Option: You have the right to buy an instrument at a prespecified price at a
prespecified maturity date.
ii. Put Option: You have the right to sell an instrument at a prespecified price at a
prespecified maturity date.
Example-2: A enters into a contract with B to sell $100 at 31 December 2024 at the option of A
Please do not think that in a call option, the other party is on a put option and vice versa.
Concept of premium: The party having the right to exercise the options (call/put) needs to pay a lump
sum amount (premium) to the other party who is obligated to entertain the rights of the option-
holder.
Working Example of Call option: A enters into a contract with B to buy 100 XYZ company’s shares at the
price of $15 (strike price/exercise price) per share at 31 December 2024. A needs to pay an upfront
payment of $1 per share as premium for this option holding.
At 31 December 2024, the market price (spot price) of the share is $17 per share.
Break Even: Strike price + Premium = $15 + $1 = $16 [ for a call option]
When a call option-holder does not exercise the option, in that case, he/she only loses the premium.
Profit from call option = maximum of [{spot price – strike price}, {0}] – Premium
Working Example of Put option: A enters into a contract with B to sell 100 XYZ company’s shares at the
price of $22 (strike price/exercise price) per share at 31 December 2024. A needs to pay an upfront
payment of $2 per share as premium for this option holding.
At 31 December 2024, the market price (spot price) of the share is $17 per share.
Break Even: Strike price - Premium = $22 - $2 = $20 [ for a put option]
Profit : Break even – Spot price = $20 - $17 = $3
When a put option-holder does not exercise the option, in that case, he/she only loses the premium.
Profit from put option = maximum of [{0}, {strike price - spot price}] – Premium
Profit from put option = maximum of [{0}, {strike price - spot price}] – Premium
Profit =Max [{0}, {95 – 96}]- 0.69 = Max [0, -1] – 0.69 = 0 – 0.69 = -0.69%