Interest swap and call/put option are used to hedge and save money. Interest swap is two higher credit-level companies swap their interest rate. The two companies swap them inters rate to save interest payment from the lower combined interest rate. The two companies can share the save money. Low credit-level company is hard to find a swap object. As the time fly, the lower credit-level companies will disappear on the swap market. So, usually interest swap is happened between two higher credit-level companies. Interest swap just swap the interest rate beside the capital. So, it has the minimal risk. European call/put options are purchase the call/put options by European style. Call/put options are used to hedge and earn. They can exercise their rights to purchase or sell a stock depend on the options promise.
Forward contract is similar with European call/put options. “Forward contract is a customized contract between two parties to purchase or sell an asset at a specified price on a future date” (Picardo/CFA, E., 2015). So, forward contract is help companies or investors to hedge the risk and earn from the different price. But, it has higher risk than interest swap. Because forward contract has a lot unknow factors can influence the price of exercise day. European call/put options also are purchase or sell an asset at a specified price on a future date. The difference between European call/put options and forward contract is the rights. Forward contract required the two parties have to exercise the contract. European call/put options do not require the two parities must to exercise the purchase or sell rights.
Compare and contrast how corporations use interest swaps and forward contract.
A swap contract is a contract in which parties agree to exchanging variable performance for a certain fixed market rate. In short, parties agree to exchanging cash flows on a future date. For Bitcoin this can either be fixed floating commodity swaps or commodity for interest swaps. Forwards come down to making an exchange at a future date. The agreements include delivering a certain amount of goods by the end of a certain period.
A swap contract compares best to a forward contrast. Although a forward has only a single payment at maturity while a swap typically involves a serious of payments in the futures. In fact, a single period swap is equivalent to one forward contract.
Discussion on the European exercise options:
A European option is an option that can only be exercised at the end of its life, at its maturity. European options tend to sometimes trade at a discount to their comparable American options. American options allow investors more opportunities to exercise the contract. European options are contracts that give the owner the right, but not the obligation, to buy or sell the underlying security at a specific price, know as the strike price, on the option’s expiration date. A European call option give the owner the right to purchase the underlying security. A European put option gives the owner the right to sell the underlying security. A buyer of an European option who does not want to wait for maturity to exercise it can sell the option to close the position.
Interest Swaps and Contracts
An agreement by two corporations to exchange interest payments on a one-stream basis over a given period is what constitutes to an interest rate swap contract (Gottesman, 2016, pg. 243). The swaps may also involve an exchange of cash flows for liabilities associated with a company such as long-term loans. The best example for swap exchange is where the corporation exchange fixed rate loan with floating rate long to minimize their financial risks in the future. Forward contracts relate to agreements between two corporations, which involve buying and selling of particular goods or financial securities at a pre-determined price in the future (Gottesman, 2016, pg.4 ). For example, a company can agree to supply a given quantity of products to another company for sales and payments are done on a future date.
Compare and Contrast
Interest swaps contracts are easy to compare with the forward contracts in that they are both future payments on the agreement made between two parties. However, forward contracts are single payments made at the end of the maturity date whereas swaps are payments made within a series of time until the end of the agreed period (Haugh, 2016, pg. 2). A corporation chooses swaps because they help in spreading financial risks and they can prevent company assets liquidation. Forward payments, on the other hand, are risky for the company as compared to swaps (Haugh, 2016, pg. 2). A company can be faced with financial risk if it is not in a position to finance for the payments at the end of the agreed period.
In addition, interest rate swaps mainly to assist the corporation in managing floating rate debt through fixed interest payments. Forward contact, unlike swap contract, cannot be used in the managing floating rate debt because they do not allow the company to balance between payment and income received.
These contracts are best applied in European option but not in American options. European options allow for the exchange of the contacts to be agreed upon at the end of the maturity date. Given the available options strategies, corporations can decide on when to choose a call or a put option in the stock market. A call option refers to the scenario whereby corporation has the right to buy stocks for other corporation at a prevailing purchase price in the future (Gottesman, 2016, pg.22). A put option applies to the right by a corporation to sell shares at a current market purchase price to another corporation in the future (Gottesman, 2016, pg.44).
Under European options, long calls are obligations in long forward contracts where corporation have rights to buy assets from their counterparts in the future. A call or a put spread is applied whereby corporation expects the price of stocks to rise hence the corporation decides to buy now and sell later at a higher price. Combining both derivatives seems suitable for the corporation since it can minimize its losses and maximize profit at the same time.
In conclusion, interest rate swaps contracts are crucial in the financial management of corporation since it helps in spreading risks of debt capital. Financial derivatives options act as a tool for participation in buying and selling of securities since they guide corporation in making a shrewd decision. European options are the best in financial market options due to the fact they allow future payments of assets with predetermined strike prices. Finally, financial derivatives options are necessary in corporation investment strategies.
Last Updated on February 11, 2019 by EssayPro