1. I nvestment A nalysis II Investment Analysis II - © 2012 Houman Younessi MGMT-6330 Investment Analysis II 1 Asset Classes, Commodities and Derivatives

2. I nvestment A nalysis II Investment Analysis II - © 2012 Houman Younessi 2 Asset Classes In order to have a diversified portfolio, we need to understand various asset classes as investment options. Assets are often classified into two distinct classes: Traditional Assets, and Alternative Investments There is no fundamental economic difference between these classes except that alternative investments generally: Are less liquid Are more difficult to value Have limited historical risk and return data Compared to traditional assets

3. I nvestment A nalysis II 3 Alternative Asset Classes Investment Funds Investment funds are intermediaries that invest investor pooled funds for a fee. The investor usually receives a share of the fund proportional to his/her investment. Investment funds are either managed or unmanaged. Unmanaged funds are also called Unit Investment Trusts and hold a fixed portfolio for the life of the trust and is often tax exempt. Unmanaged funds are usually ready to redeem investors’ shares immediately at market value. Managed funds are in turn classified in terms of their readiness to redeem investors’ funds. Open-end funds (Mutual Funds) do redeem at request Closed-end funds do not. Instead they issue shares that are then traded on secondary markets

4. I nvestment A nalysis II 4 Investment Analysis II - © 2012 Houman Younessi Traditional Asset Classes Traditional asset classes include: Domestic equity U.S. treasury bonds U.S. municipal bonds International developed market equity International emerging market equity U.S. blue chip corporate bonds Cash We have already studied these in Investment Analysis I and earlier in this course

5. I nvestment A nalysis II Investment Analysis II - © 2012 Houman Younessi 5 Alternative Asset Classes Alternative asset classes include: Investment Funds Tangible Assets Commodities Absolute Return Investments Derivatives and Exotics

6. I nvestment A nalysis II Alternative Asset Classes Investment Funds Valuation The basic valuation metric is Net Asset Value (NAV), the per share value of the investment company’s assets minus its liabilities. The most significant liability comes from fees owed to investment managers (if any). For unmanaged and open-end investment funds, the share value is the NAV as they stand ready to redeem at market value. For closed-end funds, the share price is determined in a secondary market and may be at a premium to the NAV or at a discount to it. Fees are usually calculated as a % and are either one-time or periodic (e.g. annual). One- time fees may be front-end loaded (a % of purchase) or back-end loaded (a % of value at exit). Back-end charges may be declining (reduce as you stay in the fund)

7. I nvestment A nalysis II 7 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Investment Funds Exchange Traded Funds (ETF) ETFs allow investors to buy or sell exposure to an index through a single financial instrument. They trade on a stock market just as shares of any individual company. ETFs have many advantages: Can assist in diversification. With a specific type of ETF (say an equity-oriented ETF), the investor can gain exposure to different types of capitalization (large cap, mid cap, etc.), style (value or growth), sector, industry or country or region. ETFs trade as stock and can be sold long or short or bought on margin. Traditional mutual-funds often are traded only once a day at closing, ETFs trade throughout the day.

8. I nvestment A nalysis II Alternative Asset Classes Investment Funds Exchange Traded Funds (ETF) ETFs advantages (cont’d): For many – if not most – ETFs, there exists futures and options contracts on the same index. ETF portfolios are published on a daily basis whereas other funds are only published quarterly at best. ETFs are cost efficient. You can buy exposure with one transaction that otherwise would require establishing an entire portfolio wit many individual transaction fees ETFs are cost effective. There are no load fees, and the expense ratio can be held low as there is no shareholder accounting at the account level. Dividends are reinvested immediately whereas for mutual funds timing of reinvestment varies.

9. I nvestment A nalysis II 9 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Investment Funds Exchange Traded Funds (ETF) ETFs dis-advantages: In many countries, actively traded ETFs track only a narrow-based index, such as only large-cap stocks. No ETFs are often available for mid and small cap investments. This is NOT the case in the US. Some ETFs do not have sufficient trading volume to have a small bid-ask spread. ETFs are often of limited use to very large institutional investors as they can invest directly in an index (roll their own). The costs may be less and the tax situation usually better.

10. I nvestment A nalysis II 10 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Investment Funds Exchange Traded Funds (ETF) Risks of ETFs: The following are the risk elements that must be considered when valuing an ETF. Note that not all risks impact all ETFs uniformly: Market risk: Like all other market based investments, the value/price of an ETF (NAV) changes with the changes in the market. Asset class/sector risk: Any asset class or sector may underperform the market. Trading risk: As there may always be market impediments, the ETF may trade at a discount to its NAV. Tracking error risk: ETFs are constructions. They are designed to track their corresponding index closely. They cannot guarantee this. Country and currency risk: ETFs may be subject to unfavorable fluctuation in currency or stability of the country in which the ETF has invested.

11. I nvestment A nalysis II 11 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Investment Funds Exchange Traded Funds (ETF) Applications of ETFs Implementing asset allocation: ETFs can be used to effect asset allocation among baskets of stocks, bonds and other assets Diversifying sector or industry exposure: ETFs can be used to diversify away the sector or industry specific event risks Gaining exposure to specific market on a broad basis Equitizing cash: By investing in ETFs investors may be able to put idle cash to good short-term use Adjusting the portfolio: Investors can use ETFs to quickly adjust exposure to an industry or sector to re-align an overall strategy Applying sophisticated tactics: Investors can long, short, leverage and time ETFs

12. I nvestment A nalysis II 12 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Tangible Assets Tangible assets, as opposed to financial assets, are those assets that may be touched and seen in themselves in addition to their ownership documents. Tangible assets come in a wide variety including:  Land  Buildings  Natural resources (timber, minerals, fish)  Vehicles (e.g. ships), containers, etc.  Artworks We will concentrate on Real Estate (land, buildings and land based resources), as it is by far the largest section of this category

13. I nvestment A nalysis II 13 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Real Estate Real estate investments may be actual (tangible) or derivative (intangible). Actual real estate may be: Non-value added (land) Value-added (land and buildings) Value-adding real estate (timberland, mines, etc.) Derivative real estate investment are securities derived from the sale of real estate or related to the sale of real estate (such as buying mortgages or mortgage- backed security bundles)

14. I nvestment A nalysis II 14 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Real Estate Forms of Real Estate Investment Free and clear holding: Unencumbered full ownership rights for an indefinite period Leveraged equity: Full ownership rights for an indefinite period encumbered by debt (a promissory note unrelated to the real asset under consideration) or a mortgage (a pledge that in case of inability to discharge the debt, the ownership would transfer to the mortgagor) Mortgages: Loans secured by the underlying real estate made to third parties Aggregation vehicles: Aggregates investors and gives them access to real estate investment to which they may not otherwise have access. Real Estate Limited Partnerships (RELP) and Real Estate Investment Trusts (REIT) are examples of these aggregation vehicles

15. I nvestment A nalysis II 15 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Real Estate Valuation Real estate valuation is very difficult One often has to estimate the actual value of the asset, AND the value of the potential “value added” income streams, AND the on-going cost of ownership Note that: Properties are immovable and usually indivisible and as such usually very illiquid Properties are only approximately comparable in value There is no national or international real estate auction market, to determine values by consensus Transaction costs and management fees are usually very high

16. I nvestment A nalysis II 16 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Real Estate Valuation Basically there are four approaches: 1.The replacement cost approach: How much would it cost today to replace this real asset? Of course one needs to estimate the value of land (an independent exercise), PLUS estimating today’s cost of the current improvements. This approach is limited in value as a) we still need to estimate the value of the land, and b) the market value of a building may differ enormously from its construction cost (an office building may be very valuable because it has some prestigious, long term tenants)

17. I nvestment A nalysis II 17 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Real Estate Valuation 2.The sale comparison approach: How does this property compare to a similar property whose value is known, or the median or average of a collection of “similar” properties. A variation called hedonic valuation is when the major characteristics of a property are evaluated on an ordinal (1-10) or absolute ($) scale and and used to modify the estimate. This approach has become standard in valuation of residential properties and its use in commercial appraisals is increasing

18. I nvestment A nalysis II 18 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Real Estate Valuation 3.The income approach: This method uses a perpetuity discount model to value real estate. The perpetuity is the annual Net Operating Income (NOI). NOI is gross potential income minus expenses including vacancy, collection losses, insurance, property taxes, repairs, utilities, and maintenance costs. Appraisal rate = NOI ÷ Market Cap Rate where Market Cap Rate = Benchmark NOI ÷ Benchmark Transaction Price Benchmark may be a single property or the average or median of a number of properties

19. I nvestment A nalysis II 19 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Real Estate Valuation 4.The discounted after-tax cash flow approach: This method is based on the fact that an investment is worthwhile when its expected net present value is positive. Alternatively, the investment yield (internal rate of return) should exceed the investor’s required rate of return. WORKSHOP

20. I nvestment A nalysis II 20 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Commodities While investing in most stocks and in corporate bonds allow the investor to invest in an economy’s manufacturing and service sectors, and government bonds allow investment in the government, commodities allow investment in the primary production of an economy. Commodities generally come in three categories: Agricultural and farming products (soft commodities: Fibers, grains, livestock, beverages (coffee, cocoa, etc), spices, dairy Energy: Oil, gas, electricity Minerals: Gold, silver, copper, coal, aluminum

21. I nvestment A nalysis II 21 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Commodities Most investors do not wish to store grain or oil or tend to animals. Very few investors (as opposed to consumers) buy the actual commodity. Investment in commodities is usually indirect by way of: Future contracts Commodity or inflation indexed bonds Stock of primary production companies

22. I nvestment A nalysis II 22 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Commodities Futures Contracts As we have learned, a futures contract is a standardized, exchange-traded agreement between two parties in which the buyer agrees to buy an asset from the seller at a future date at a price agreed upon at contract time. Futures contracts are the easiest and cheapest way to invest in commodities. There are two types of commodities futures indices: Broad-based (tracker) Investible Index

23. I nvestment A nalysis II 23 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Commodities Futures Contracts Broad-based Tracking Indices: Several commodity indices have been developed. Some traditional indices are broadly based and have a global perspective and aim to track the changes in input prices. Investible Indices: are in turn based on a limited basket of the most liquid commodity futures contracts so they can be easily replicated by taking proportional positions in the participating commodities. For example, the Goldman Sachs Commodity Index (GSCI) is a world-production weighted index of 24 commodities with liquid futures contracts Although available elsewhere, commodities usually have their own exchanges. For instance the Chicago Mercantile Exchange (CME) is the largest of its kind in the US.

24. I nvestment A nalysis II 24 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Commodities Commodity-Linked Bonds During inflationary periods, many governments have been forced to offer loans (bonds) with coupons or principal indexed to either the price of a specific commodity or an inflation index. Examples are: The Gilt in Britain (based on the price of gold and introduced in the 1980s) and the Treasury Inflation Protected Securities (TIPS). The principal is indexed to the consumer price index CPI and as such (somewhat indirectly) to commodity prices. Many other countries such as France, Australia, Sweden, Canada, and Italy have offered bonds based on the price of gold, oil, or agricultural products.

25. I nvestment A nalysis II 25 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Commodities Stock of Primary Production Companies BHP Billiton (BHP) is an Australian conglomerate involved in oil production, oil exploration, gold mining, agriculture, coal, bauxite, and commodities management. Of course buying a share of BHP Billiton would be investing in a diversified basket of commodities!! There are many companies similar to BHP and those that are more focused on a single or narrow range of commodities such as Exxon-Mobil. Single product mining companies are a good example of a stock very directly influenced by the price of the underlying product.

26. I nvestment A nalysis II 26 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Commodities Investment Features Commodities tend to have positive correlation with inflation They tend to have a low or negative correlation with stocks Supply and demand clearly has a determining role in the price of commodities as often do weather and fuel (transportation) costs. The general growth in population and demand from emerging nations would in long-term help to increase all commodity prices Improvements in technology, transport and means of production would tend in long-term to lower commodity prices.

27. I nvestment A nalysis II 27 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Commodities Investment Examples Futures: Cocoa (CJ, CC); Coffee (C, KC, KT, KO); Corn (ZC); Cotton (TT, CT) Company Stock: Monsanto (MON); Deere and Co. (DE); Bunge (BG) Funds: DB Agriculture Fund (DBA); MLCX Grains Index (GRU); Dow Jones USB Cocoa Total Return (NIB); Dow Jones USB Sugar Total Return (SGG)

28. I nvestment A nalysis II 28 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Many investments seek above market returns (alpha) through pursuing opportunities that do not correlate with specific market securities, indices or securities markets. In fact, the only way to generate alpha is to go beyond the characteristics and provisions of the market. There are two ways of creating such absolute return: Working outside the “market” Playing “against” the market

29. I nvestment A nalysis II 29 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Private Equity Investing Working outside the markets means creating absolute return and hopefully absolute value, by working outside or almost outside the context of the public securities market. Private Equity Investment is the means by which an investor can play outside or almost outside the securities markets sandbox. There are several approaches:  Venture capital investing  Privatization through buy-outs, takeovers, (management buy-outs), and leveraged buy-outs  Vulture (distressed asset) Investing

30. I nvestment A nalysis II 30 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Playing against the market means using hedging and other techniques to try to create opportunities to reduce or eliminate risk or increase return not normally available in the regular market. Although the original “hedge funds” were funds that used hedging to secure an advantage, today this term is applied to a wide variety of funds whether or not they engage in hedging. Colloquially, a hedge fund these days is any fund that:  Uses sophisticated means and vehicles of investing to isolate specific bets to generate alpha  Is focused on performance relative to a pre- assigned benchmark  Has greater flexibility (fewer constraints) in how it can invest  Has a small and “elite” client base with high barrier to entry

31. I nvestment A nalysis II 31 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Private Equity Investing Private equity investing has several characteristics that although some are common to other alternative investing in general, make private equity investing what it is:  Illiquidity  Long term commitment required  Difficulty in valuation  Limited historical risk and return data  Investor (equity company) and management mismatch  Hands-on

32. I nvestment A nalysis II 32 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Classifications  Long/Short (Real Hedge) Funds  Market-Neutral Funds  Macro (Global Macro) Funds  Managed Futures Funds  Emerging Markets Funds  Emerging Sectors Funds  M&A Arbitrage Funds  Fund of Funds Funds

33. I nvestment A nalysis II 33 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Classifications Long/Short funds are traditional hedge funds, taking short and long bets in generally common stocks. They vary their long and short exposures according to forecasts, use leverage and operate on numerous markets throughout the world. They often maintain net positive or net negative positions. These funds are seeming the simplest in terms of philosophy but often amongst the most sophisticated in terms of execution and technology (they need to be).

34. I nvestment A nalysis II 34 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Classifications Market neutral funds attempt to hedge against a general market movement. They take bets on valuation differences of individual securities or funds within some market segment. This could involve simultaneous long and short positions in closely-related securities with a zero net exposure to the market itself. A market-neutral portfolio is usually constructed so it is: Dollar neutral (equal $ value of long and short positions) Beta neutral (total sensitivity of long positions equal that of short positions) Long positions may be (usually are) in stocks considered undervalued, and the shorts are in stock considered overpriced. Leverage is generally and often liberally used to enhance the returns

35. I nvestment A nalysis II 35 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Classifications Global Macro Funds take bets on the direction of a market, a currency, an interest rate, a commodity, or any macroeconomics variable. These funds tend to be highly leveraged and make extensive use of derivatives. There are many sub-groupings but three are particularly prominent: Managed Futures Funds Emerging Markets Funds Emerging Sectors Funds

36. I nvestment A nalysis II 36 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Classifications Managed Futures Fund are pools in which fund managers take bets on directional moves in the positions they hold (long or short) usually in a single asset class, such as currency, fixed income, or commodities and tend to use many actively traded futures contracts.

37. I nvestment A nalysis II 37 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Classifications Emerging–markets funds primarily take bets on all types of securities in emerging markets. The securities in these economies are usually less efficient and less liquid than those in the developed markets thus allowing for greater arbitrage potential. But as there typically is not an organized lending market for securities, it is difficult to sell short or leverage most positions. Emerging markets represent growth but they also tend to be more volatile and subject to political and currency risks.

38. I nvestment A nalysis II 38 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Classifications Emerging-sectors funds primarily take bets on all types of securities in emerging sectors and technologies. These securities are usually subject to a good deal of growth although there is a corresponding level of volatility. As emerging sectors are by definition new, there is little historical data to guide investment.

39. I nvestment A nalysis II 39 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Classifications Merger and acquisition arbitrage funds bet on the price difference between the stock price of a company just before merger or acquisition goes through and the acquisition strike price. Before the effective date of a merger, the stock of the acquired company will typically sell at a discount to its acquisition value as officially announced. A hedge fund manager simultaneously buys stock in a company being acquired and sells short stock in the acquirer.

40. I nvestment A nalysis II 40 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Classifications Funds of funds have been created to allow easier access to hedge funds by small investors. An FoF has access to a large potential investor base (albeit each may invest a much small amount; that is the point) but has enough funds to invest in a variety of hedge funds thus providing retailing, access, diversification, and expertise to those who otherwise may not be able to enjoy these in the context of multiple hedge funds. There are drawbacks with FoFs. They have fees of their own on top of the base hedge fund fees, their performance will be diversified (diluted) if not all funds perform. Also, as funds in FoFs are selected based on past performance, they may be already passe by the time they make it into a FoF.

41. I nvestment A nalysis II 41 Investment Analysis II - © 2012 Houman Younessi Alternative Asset Classes Absolute Return Investments Hedge Funds Sources and Indices There are literally thousands of hedge funds around. To be able to operate as a true hedge fund, they are not allowed (by the SEC) to advertise for the purpose of investor solicitation. However, there are several firms, banks, index providers and even educational institutions that provide indices in which these funds can “volunteer”. These include: Specialist firms: Hedge Fund Research, Van Hedge, Hennessee, Greenwich Banks: Credit Suisse/Tremont, ABN AMRO EurekaHedge Index providers: MSCI, S&P, FTSE Educational Institutions: CISDM (Umass), EDHEC (school in France)

42. I nvestment A nalysis II 42 Investment Analysis II - © 2012 Houman Younessi Derivatives The previous pages show us that we no longer live and invest in the simple world of stocks and bonds. Many new instruments have emerged, several – if not most – of which no longer represents a direct investment in an asset but ones that offer a return based on the return of another underlying asset. These are called derivatives. Derivative: A financial instrument that offers a return based on the return of some other underlying asset. Derivatives are called thus as their value is derived from the return of the underlying asset A derivative is a contract that initiates on a certain date and terminates on a later date. Often (but not always) the payoff is determined on the expiration date

43. I nvestment A nalysis II 43 Investment Analysis II - © 2012 Houman Younessi Derivatives Types of Derivatives There are two distinct but ultimately related markets for derivatives. Derivatives may be: Exchange traded contracts: which have standard terms and features and are traded on an organized trading facility/exchange such as a futures exchange or an options exchange. Over-the-counter contracts: which are transactions created by two parties but not traded on an exchange and usually representing a “private” deal vis a vis an underlying. This could be a wide array of deals including purchasing of insurance.

44. I nvestment A nalysis II 44 Investment Analysis II - © 2012 Houman Younessi Derivatives Forms of Derivatives There are two distinct forms of derivatives. Derivatives may be: Forward commitments: which are agreements between two parties in which one party agrees to buy from the other party an underlying asset at a future date at a price established at the start. Contingent claims: which are derivatives in which the payoff occurs if a specific event occurs. We generally call these types of claims as options.

45. I nvestment A nalysis II 45 Investment Analysis II - © 2012 Houman Younessi Derivatives Forms of Derivatives Forward Commitments Forward commitments come in three categories: Forward contracts or Forwards: This is a forward commitment in which the two parties “privately” design and therefore customize the deal. The underlying could be anything from a pizza to Pizza Hut Inc. Futures contracts: which are a variation of a forward commitment that is a public, exchange-traded, standardized transaction the protection re the default on which is guaranteed by the exchange. Futures are available on a wide range of commodities, currencies, stocks, funds, etc. Swaps: which are a variation of a forward contract (actually it is simply a series of forward contracts) in which the parties agree to swap a series of future cash flows. Generally at least one cash flow’s value is determined by a later outcome

46. I nvestment A nalysis II 46 Investment Analysis II - © 2012 Houman Younessi Derivatives Forms of Derivatives Contingent Claims Warrants Options are by far the largest category of contingent claims. Other forms of contingent claims (all having option-like features) are: Warrants: are issued by the firm whose stock (sometimes bonds) serves as the underlying. At the time of issue, a warrant entitles the holder to purchase one share of the stock for the appropriate exercise price. Further stock splits may alter the proportion, always reflecting the original offer. The major differences between warrants and call options are that: Warrants have longer expiry than call options, sometimes they are perpetual; Warrants are dilutive, when a warrant is exercise, the company must issue new stock; Most warrants are over-the-counter

47. I nvestment A nalysis II 47 Investment Analysis II - © 2012 Houman Younessi Callable/Putable bonds: We have seen these before (lecture 3). A callable/putable bond gives the issuer/buyer the right to redeem the bond for a pre-agreed price before the maturity or (in rare occasions) under certain pre- specified conditions). Derivatives Forms of Derivatives Contingent Claims Callable/Putable Bonds

48. I nvestment A nalysis II 48 Investment Analysis II - © 2012 Houman Younessi Convertible bonds: Again, we have seen these before. A convertible bond is a bond that carries the right at the holder’s option (the contingent claim) to convert it to another security, often common stock. Derivatives Forms of Derivatives Contingent Claims Convertible Bonds

49. I nvestment A nalysis II 49 Investment Analysis II - © 2012 Houman Younessi Asset-backed Securities represent a claim on a pool of securities which may be mortgages, automotive loans, bonds, and similar instruments. As borrowers always have the option to pre-pay these loans when interest rates are favorable (re-finance), they hold an option. The investor who buys into the pool of such loans, is in fact selling an option. Derivatives Forms of Derivatives Contingent Claims Asset-backed Securities

50. I nvestment A nalysis II 50 Investment Analysis II - © 2012 Houman Younessi Derivatives Forms of Derivatives Contingent Claims Options All contingent claims have an option (in the sense of a choice to take action) at their core. As such one can consider them all as types of option instruments (some do). A proper option however is usually a standardized, more often than not exchange traded instrument that has a contract associated with it called a term sheet that at a minimum specifies the following: The underlying asset The right(s) or exercise terms, (call/put) Settlement terms (e.g. deliver the underlying or an equivalent value) Expiration date Strike price (the price of the underlying) Option price (the premium payable/paid to hold the option) We shall study options and their pricing in the next lecture