FINANCIAL MARKETS

Economics of International Financial Markets

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Economics of International Financial Markets

Ques1) Explain briefly what options are and distinguish between call/put options and writer/buyer of options.

Ans1) An option is a financial instrument which is a set of contract that gives the buyers the right but not the obligation to buy or sell an asset or securities i.e. the underlying assets which can be a stock, bonds or anything at a predetermined price (strike of exercise prices) until a specified date (maturity). Options are of two types one is termed as call options and other is termed as put options.

The difference between the call/put options and writer/buyer of options are as followed. A call option provides the buyer the right but not the obligation to purchase an underlying asset at a predetermined price on a precise date.

Call option seller has the obligation to sell the asset if the buyer exercises the right to buy (Smith C., 1996, pp. 73).

Buying a Call Option: Buying a call option is interesting when expectations are bullish on the future evolution of the stock market.

Selling a Call Option: In selling a call option, the seller receives the premium (option price). In return, is obliged to sell the stock at the fixed price (strike price) in case the call option buyer exercises his right to purchase, with a gain of the buyer's premium minus any price difference between current and the stike price. A call option can be sold without having previously purchased the underlying asset.

A Put option gives its holder the right but not the obligation to sell an asset at a predetermined price until or on a specific date in the case of American option. The seller of the put option has the obligation to buy the underlying asset if the option holder (buyer the right to sell) decides to exercise his right.

Put Option (Buying): A right to sell the asset is termed as put option. Buying a put option is buying the right to sell.

Put Option (Selling): Put option seller is selling a right for which the premium charged. Since selling the right, assumes the obligation to buy stock in the event that the buyer of the put exercise its right to sell (Ross S., 1976, pp. 75).

Ques2) What is meant by “hedging against adverse currency movements”? How might Allied-Lyons may have hedged?

Ans1) The concept of hedging is not possible without the notion of risk. The risk is the probability (risk) of losing a part of their resources, shortfalls in income or work extra costs resulting from the implementation of certain financial transactions. Any asset, cash flow or financial instrument cannot be separated from risk. These risks, in accordance with generally accepted classification, divided largely on price and interest. Separately, you can allocate the risk of non-contractual obligations (as the financial instruments are essentially contracts), called the credit.

Thus, hedging is use as a tool to reduce the risk of adverse market factors that influence the price of another, a related instrument, or cash flows ...