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# Derivatives Intro 1

Authors
•  Name
Yair Mark
@yairmark

Today I went on the first of a 2 days of training on derivatives. The main points that stood out for me today were:

# What

It is a contract that derives its value from an underlying entity.

## Main Formulae

``````FV = PV x ( 1 + i x (days/daysInYear))
``````
``````PV = FV / (( 1 + i x (days/daysInYear)))
``````
``````i = (((PV x FV) - 1) x daysInYear) / (days)
``````
1. `daysInYear`

• This is very dependent on which market its for:
• For South Africa its 365.
• For Euro and Dollar for example its 360.
2. `days`

• This is based on days in a month:
• 1 Month = 30 days so 3M = 90 days
3. `i`

• The current quoted rate.
• If this is an interest rate derivative then this rate is the interest rate at the point in time this formula is being calculated.
4. `PV`

• This is the present value of the nominal that will be used in the calculation.

## Types of Derivatives

1. F`o`rward
• Only OTC.
• Easy way to remember it has an `O` so OTC.
• The contract obliges the buyer to pay the agreed amount when it reaches the maturity date.
2. Futur`e`
• Exactly the same as a forward but it is handled on exchanges.
• Easy way to remember it has an `E` in.
3. Swap
• This is when two parties exchange cash flows.
4. Option
• You have the option of buying something at a certain price in future.
• You do both have to buy it when that time comes - this comes at a premium.

All other derivatives are forms of these.

## FRA

This is a derivative against an interest rate. In South Africa a vanilla FRA is linked to the 3M JIBAR hence the reason why FRAs are 3 months long in South Africa.

It is normally named as below where the first portion is when the FRA starts relative to the trade date and the second portion is when the FRA ends relative to the trade date. For example a 3x6 FRA starts 3 months from the trade date and matures 6 months from the trade date.

FRAs are always OTCs (`F` stands for Forward which as described before is always OTC).

### Valuing an Already Purchased FRA in the future

• If for example you have bought a 3x6 FRA and one month in how do you price it?
• You price a 2x5 and take the difference between your original and that to see the price change

## Terminology

• Speculate - you use a derivative as you hope to make a profit.
• Hedge - you use a derivative to guard against risk.
• Nostro account - this is an account that a bank holds in a foreign currency in another bank.
• Notional amount - This is the amount used in the calculation of the amount that needs to be paid on an instrument. This notional amount does not change.