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Forward Commitments and Contingent Claims

Derivatives can be classified into two groups: forward commitments and contingent claims. Forward commitments involve an agreement between two parties to engage in a transaction at a future date at an agreed upon price. Contingent claims are derivatives whose payoffs occur depending on a specific event, such as the payoff of an option being contingent on the occurrence of the underlying asset reaching a certain price. Common types of contingent claims include options, convertible bonds, callable bonds, warrants, and exotic options.

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179 views2 pages

Forward Commitments and Contingent Claims

Derivatives can be classified into two groups: forward commitments and contingent claims. Forward commitments involve an agreement between two parties to engage in a transaction at a future date at an agreed upon price. Contingent claims are derivatives whose payoffs occur depending on a specific event, such as the payoff of an option being contingent on the occurrence of the underlying asset reaching a certain price. Common types of contingent claims include options, convertible bonds, callable bonds, warrants, and exotic options.

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maryani
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FORWARD COMMITMENTS AND CONTINGENT CLAIMS

Based on the rights and obligations of the parties that enter into the contract, derivatives can
be classified into two groups:

A. FORWARD COMMITMENTS
B. CONTINGENT CLAIMS

FORWARD COMMITMENTS

• These are contracts in which the two parties enter into an agreement to engage in a
transaction at a later date at a price established at the start.
• A forward commitment is an agreement between two parties in which one party agrees
to buy and the other agrees to sell an asset at a future date at a price agreed on today.
• In essence, a forward commitment represents a commitment to buy or sell. Ex are
Forward contract; Future contract; Swap

CONTINGENT CLAIMS

• Contingent claims are derivatives in which the payoffs occur if a specific event happens.
• A contingent claim is a derivative contract with a payoff dependent on the occurrence of
a future event. It can be either exchange-traded or over-the-counter.
• The primary types of contingent claims are options. The payoff of an option is
contingent on the occurrence of an event.

Types of Contingent Claims

Other types of contingent claims involve variation of options, often combined with other
financial instruments or derivatives such as:

• Convertible Bonds - Convertible bonds are bonds that can be exchanged for the stock of
the issuing firm at a pre-agreed time and exchange ratio. The bondholder has an option
to participate in gains on the market price of the firm's stock without having to
participate in losses on the stock.
• Callable bonds - Callable bonds are redeemable by the issuer before the maturity under
specific conditions and at a stated price. The issuer has an option to pay off the bonds
before maturity
• Warrants - Warrants are securities entitling the holder to buy a proportionate amount
of stocks at some specified future date at a specified price. They are similar to call
options.
• Exotic options - Exotic options are options that are more complex than basic put or call
options. Exotic options trade over-the-counter.
• Interest rate options - Interest rate options are options whose underlying asset is an
interest rate.
• Options on futures - Options on futures are options whose underlying asset is a futures
contract. They are all exchange-traded.
• Asset-backed securities - Asset-backed securities are securities that are collateralized by
a pool of securities such as mortgages, loans or bonds. Typically borrowers of
mortgages, loans or bonds have the prepayment option to pay off their debts early.

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