Paola Lucantoni
Financial Market Law and Regulation
 Forward agreements
 Swaps
 Options
Forward agreements
 Def:
 A forward agreement is an agreement
 between two parties
 for the consignment of a specific quantity of a certain
underlying product
 at a pre-established price (strike price)
 and on a pre-established date (maturity date).
 underlying product
 financial assets, such as shares, bonds, currency,
financial instruments, derivatives, etc;
 goods, such as oil, gold, grain, etc..
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The purchaser of the forward agreement
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The seller
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undertakes on maturity to hand over the underlying product in order to receive the strike price
a short position.
at the time of their finalization, the short and long position are usually equivalent.
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undertakes on maturuty to pay the strike price in order to receive the underlying products
a long position
consignment price equal to the forward price
forward price = current price of the underlying products (so-called spot price) increased by the
financial value of the time running between the date of stipulation and the maturity date
Exception: up front
over the duration of the agreement,
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Changes related to the current priceof the underlying product
 risk/return profile of a forward agreement
 for the purchaser of the agreement
 for the seller of the agreement,
aims
- hedging purpose
- speculative purpose
- arbitrage purpose
 The execution of the agreement on maturity
 physical delivery - effective consignment of the
underlying assets by the seller to the purchaser
 cash settlement - payment of the differential in cash
between the current price of the underlying product, on
maturity, and the consignment price indicated in the
agreement
 forward contracts
 OTC
 Futures
 standardized and traded on organized markets.
 Object - the underlying assets of the contract
 dimension - nominal value of the contract
 maturity date
 trading rules
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the dealing hours;
the minimum price change which can be listed on the futures market
(so-called tick);
the formalities for settling the transactions;
the consignment locations.
Swaps
 Def. : two parties agree to exchange payments flows
between them (also called cash flows) on certain dates
 the initial value of the contract is usually 0
 Exception: up front
 Interest rate swaps (IRS):
 agreements in which two counterparts exchange
periodic interest payments, calculated on a sum of
money, called notional principal amount, for a preestablished period of time equating to the duration of
the agreement (maturity or termination date).
 Currency swaps
 "exchange of currency", are agreements where two
parties exchange the principal and the interest
expressed in one currency against principal and interest
expressed in another currency.
 Credit Default Swaps
 are agreements where a party (so-called protection
buyer), against periodic payments made in favour of the
counterpart (so-called protection seller), protects itself
from the credit risk associated with the specific
underlying product, generally referred to as a reference
asset, which may be represented by a specific issue, an
issuer or an entire portfolio of financial instruments.
Options
• Def:
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an agreement which assigns the right, but not the obligation, to
purchase (call option) or sell (put option)
a certain quantity of an asset (underlying)
at a pre-established price (strike price or exercise price),
by a certain date (maturity), in which event we are dealing with
an American option, or on reaching said date, in which case we
are dealing with a European option.