EBF 301
Global Finance for the Earth, Energy, and Materials Industries

Reading Assignment: Lesson 10

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Reading Assignment:

Errera & Brown - Chapters 4 & 6

Key Points of Emphasis

  • Non-exchanged traded financial derivatives are known as "over-the-counter" (OTC).
  • Swaps and Spreads trade OTC while Options are exchange and OTC traded.
  • Swaps are exchanges of payments between two Buyers. They are financially settled.
  • Swaps are normally "fixed-for-floating" whereby one price is the current market price ("fixed") and the other price is the future settlement price ("floating").
  • Spreads are trades which occur between commodity locations and times, as well as intra-market and inter-market.
  • Options give the Holder of the Option the right but not the obligation to buy or sell a commodity at a particular price for a specific date and location in the future.
  • Options are price risk insurance and a premium is paid for Options contracts.
  • Premiums paid are substantially less than the outright commodity contracts.
  • Option premiums are determined using mathematical models. The most well-known is the Black-Sholes.
  • "Put" Options give the Buyer a "floor" price, whereas "Call" Options establish a "ceiling" price for the Buyer.
  • Options Buyers are only exposed to the cost of the premiums.
  • The Seller (Writer) of an Option assumes all the risk.