RSM320H1 Chapter Notes - Chapter 16: Executory Contract, Underlying, Interest Rate Risk
Document Summary
Financial instruments: contracts that create both a financial asset for one party and a financial liability or equity instrument for the other party. Primary financial instruments: include most basic financial assets and financial liabilities such as receivables and payables, and equity instruments such as shares. Derivatives are financial instruments that create rights and obligations that transfer financial risk from one party to the another party. Derivatives have the following characteristics: their value changes in response to the underlying instrument (cid:894)the (cid:862)u(cid:374)derl(cid:455)i(cid:374)g(cid:863)(cid:895, they require little or no initial investment, they are settled at a future date. If the share price goes up, the option is worth more; If the share price goes down, the option may become worthless. Derivatives are used to manage financial risks: credit risk. Risk to one party that the other party will fail to meet an obligation: liquidity risk. Risk of not being able to meet own financial obligation: market risk.
