Finance can be broken into 3 various sub-categories:
Thist story was originally published in the May edition of Scientific American.
We are posting it in light of recent news involving Lehman Brothers and Merrill Lynch. Beginning last year, an investor could buy or sell a contract whose value depended entirely on fluctuations in temperature or accumulations of rain, hail or snow.
These weather derivatives might pay out, for example, Thesis on currency derivatives the amount of rainfall at the Los Angeles airport ranged between 17 and 27 inches from October through April.
They are a means for an insurer to help provide for future claims by policyholders or a farmer to protect against crop losses. Or the contracts might allow a heating oil supplier to cope with a cash shortfall from a warmer than expected winter by purchasing a heating degree-day floor—a contract that would compensate the company if the temperature failed to fall below 65 degrees as often as expected.
Weather derivatives mark an example of the growing reach of a discipline called financial engineering. This bailiwick of high-speed computing and the intricate mathematical modeling of mathematicians, physicists and economists can help mitigate the vagaries of running a global business.
It entails the custom packaging of securities to provide price insurance against a drop in either the yen or the thermometer. The uncertainties of a market crash or the next monsoon can be priced, divided into marketable chunks and sold to someone who is willing to bear that risk—in exchange for a fee or a future stream of payments.
Jarrow, a professor of finance at Cornell University.
The engineering of financial instruments has emerged in response to turbulence during recent decades in ever more interconnected world markets: The creative unleashing of new products continues with increasingly sophisticated forms of securities and derivatives—options, futures and other contracts derived from an underlying asset, financial index, interest or currency exchange rate.
New derivatives will help electric utilities protect against price and capacity swings in newly deregulated markets.
Credit derivatives let banks pass off to other parties the risk of default on a loan. Securities that would help a business cope with the year bug have even been contemplated. This ferment of activity takes place against a tainted background.
Concerns have also focused on the integrity of the mathematical modeling techniques that make derivatives trading possible. Despite the tarnish, financial engineering received a valentine of sorts in October.
Scholes and Robert C. Merton, two of the creators of the options-pricing model that has helped fuel the explosion of activity in the derivatives markets. Options represent the right but not the obligation to buy or sell stock or some other asset at a given price on or before a certain date.
Another major class of derivatives, called forwards and futures, obligates the buyer to purchase an asset at a set price and time.4 In the area of cross-currency derivatives the fairly steady appreciation of the dollar against the yen until August, fuelled activity in related options, offsetting somewhat the decline in intra-European business and emerging market currencies.
Oct 21, · A firm may hedge currency risk with a currency swap or some other product for long periods. A hedge in place in may have started back in Not really sure how regression analysis would look.
currency based on a fixed price and the other party pays periodic amounts of the same currency based on the price of a commodity, such as natural gas or gold, or a . Trends In Economics: A Calculus of Risk Mathematicians, physicists and economists can help mitigate the vagaries of running a global business through derivatives By .
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