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ASC460 Financial Derivatives UITM Assignment Answer Malaysia 

ASC460 Financial Derivatives is a comprehensive course offered by Universiti Teknologi MARA (UiTM) in Malaysia. The ASC460  course covers the theoretical foundations of financial derivatives, including pricing models, risk management techniques, and the role of derivatives in the broader financial system. Students will also explore the regulatory framework governing derivative markets and the ethical considerations associated with their use.

Through a combination of lectures, case studies, and practical exercises, students will develop the skills and knowledge required to analyze, evaluate, and employ derivative products effectively. The ASC460 course will also emphasize the practical application of derivatives in real-world scenarios, enabling students to make informed decisions and strategies within a financial context.

Upon completion of ASC460 Financial Derivatives, students will be equipped with a strong foundation in derivative products, enabling them to pursue careers in financial institutions, investment firms, risk management departments, and other areas of the finance industry.

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Assignment Task 1 :outline the concept of financial risk management and derivatives

Financial Risk Management:

 Financial risk management refers to the process of identifying, assessing, and mitigating potential risks that can affect the financial health and stability of an individual, company, or organization. It involves various strategies and techniques aimed at minimizing the impact of risks and ensuring the achievement of financial goals.

Derivatives:

 Derivatives are financial instruments that derive their value from an underlying asset or security. They are contracts between two or more parties, and their value is based on the fluctuations in the price or value of the underlying asset. Derivatives serve as tools for managing financial risks by allowing investors to hedge against potential losses or speculate on future price movements.

Assignment Task 2 :Analyse the use of derivative securities as tools in managing financial risk

Derivative securities are extensively used in managing financial risk due to their inherent characteristics. 

Here are some ways in which derivatives are utilized for risk management:

  • Hedging: Derivatives enable market participants to hedge against price volatility and mitigate potential losses. For example, a farmer can use futures contracts to lock in a predetermined price for their crop, protecting them from adverse price movements.
  • Risk Transfer: Derivatives facilitate the transfer of risk from one party to another. Insurance contracts, such as credit default swaps, allow lenders to transfer the risk of default on a loan to another entity, reducing their exposure to credit risk.
  • Speculation: While risk management is the primary purpose, derivatives also offer opportunities for speculation. Investors can take speculative positions on the future direction of an asset’s price, aiming to profit from price movements.
  • Arbitrage: Derivatives can be used for arbitrage strategies, where traders exploit price discrepancies between related assets or markets. By simultaneously buying and selling related derivatives, traders can profit from temporary price differences.

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Assignment Task 3 :Define the key terms of financial economics at an introductory level

  • Asset: Something of value that is owned or controlled by an individual, company, or organization, which can generate future economic benefits.
  • Liability: A financial obligation or debt owed by an individual, company, or organization to another entity.
  • Risk: The potential for loss or uncertainty associated with an investment or decision.
  • Return: The financial gain or loss on an investment or business activity, typically expressed as a percentage of the initial investment.
  • Portfolio: A collection of investments held by an individual or institution.
  • Diversification: Spreading investments across different assets or asset classes to reduce risk by not relying on a single investment.
  • Interest Rate: The cost of borrowing money or the return earned on investments, expressed as a percentage.
  • Inflation: The rate at which the general level of prices for goods and services is rising, eroding purchasing power.
  • Liquidity: The ease with which an asset or security can be bought or sold without causing significant price movements.
  • Capital: Financial resources, such as cash or assets, used to generate income or wealth.

Assignment Task 4 :Compare the different types of derivative instruments

There are various types of derivative instruments available in financial markets. Here is a comparison of some common types:

  • Futures Contracts: Standardized agreements to buy or sell an underlying asset at a predetermined price and future date. They are traded on organized exchanges and have high liquidity.
  • Options Contracts: Contracts that provide the buyer with the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price within a specific period.
  • Swaps: Agreements between two parties to exchange cash flows or liabilities based on predetermined terms. Common types include interest rate swaps and currency swaps.
  • Forwards Contracts: Similar to futures contracts, but they are customized agreements between two parties. They are not traded on exchanges and are often used for non-standardized or over-the-counter transactions.
  • Credit Default Swaps (CDS): Insurance-like contracts that allow investors to hedge against the risk of default on a particular debt instrument, such as bonds or loans.

Assignment Task 5 : Illustrate and produce payoff, profit of basic derivatives contracts and also profit of basic trading strategies

To illustrate basic derivatives contracts and their outcomes, let’s consider two common types: futures contracts and options contracts.

  • Futures Contract: A futures contract is an agreement to buy or sell an asset at a predetermined price on a specific future date.
  • Payoff: The payoff of a futures contract depends on the price of the underlying asset at the contract’s expiration. If the price is higher than the contract price (long position), the payoff is positive. If the price is lower (short position), the payoff is negative.
  • Profit: Profit from a futures contract is the difference between the contract price and the market price at which the contract is closed. Positive profit is earned if the contract is closed at a higher price (long position) or a lower price (short position) compared to the contract price.
  • Options Contract: An options contract provides the buyer with the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price within a specific period.
  • Payoff: The payoff of an options contract depends on the price of the underlying asset at the expiration of the contract and the strike price. For a call option, the payoff is positive if the asset price is higher than the strike price. For a put option, the payoff is positive if the asset price is lower than the strike price.
  • Profit: Profit from an options contract is the difference between the market price of the underlying asset and the strike price, minus the premium paid for the option. Positive profit is earned if the contract is exercised and the resulting gain exceeds the premium paid.

Basic Trading Strategies:

  • Long Position: Buying a derivative contract with the expectation of the underlying asset’s price to increase. Profits are realized if the price rises.
  • Short Position: Selling a derivative contract with the expectation of the underlying asset’s price to decrease. Profits are realized if the price falls.
  • Hedging: Taking a position in a derivative contract opposite to an existing exposure to mitigate potential losses from adverse price movements.
  • Spread Trading: Simultaneously entering into two derivative contracts with different terms (e.g., different expiration dates or strike prices) to take advantage of price differentials.

These are simplified explanations, and real-world derivatives trading involves more complexity and risk. It is essential to thoroughly understand the terms and risks associated with each derivative instrument before engaging in trading activities.

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