In this chapter we will explain what can be traded on an exchange. It is various types of underlying assets and their derivatives. Underlying assets are mostly traded in a way that you buy or sell them for current market prices (the “spot price”) and the trade is settled at the same time. For example, if you buy the underlying asset in the form of stocks of a particular company, the transaction will be concluded and physically settled right away. I. e. you become the owner of the stocks immediately after the purchase.
In the case of derivatives, which belong to “termed” instruments, the situation is different. By purchasing derivative of a certain underlying asset you also conclude a business transaction with specific conditions (price, quantity, quality), yet the real settlement of this transaction will take place in the future, on a precisely specified date. We will address the issue of derivatives in detail in the next part of this chapter. First, let’s look at Table 1 containing the most common types of underlying assets.
TYPES OF UNDERLYING ASSETS
|Stocks||Stocks represent shares that their owner has in a stock company. Thus they represent the right to participate in the company’s profit (in the form of dividends). The stockholder is not liable for company debts. Stocks of some companies are traded on stock exchanges where the supply and demand for these stocks determine their market value. For example, you can buy stocks of Apple or Facebook on the New York Stock Exchange or ČEZ on the Prague Stock Exchange.|
|Stock indices||A stock (equity) index (also known as stock exchange index) is an indicator of the development of the stock market as a whole. It reflects both the current state of the market and the long-term development tendencies (trends). Every stock and over-the-counter market has its own index. The index value is calculated by various methods from the value of all stocks belonging to the index. Among the best-known stock indices in the US are S&P 500 (weighted average of stock prices of 500 selected US companies) and Dow Jones Industrial Average.In Europe the best known and most traded stock indices include German DAX. It is calculated from 30 largest and most liquid German companies, such as Allianz, Commerzbank, Siemens, Volkswagen, etc., which are traded on the Frankfurt Exchange. Stock indices are traded via futures derivatives.|
|ETFs (Exchange Trated Funds)||ETFs are exchange-traded funds, yet be careful, they are not the classic mutual funds which offer various banks. ETFs are stock market funds which unlike the conventional mutual funds issued their own tradable stocks. By buying an ETF you get the entire portfolio of stocks belonging to a stock exchange index. ETFs also usually closely follow the development of the indices. However, they are cheaper since there are not so significant price movements. Trading with ETFs is suitable for beginners because it does not require a high initial capital.|
|Commodities||Market-traded goods with no difference in quality. The quality is guaranteed and deliveries from various suppliers are therefore interchangeable. In other words, commodities are products produced in large quantities by many different producers. They include, for example, energies (oil, natural gas), agricultural products, meat, cattle, and so on. Commodities can be traded directly as underlying assets on the spot markets (“cash markets”) where trades are concluded in cash at current market prices. Within such transaction the commodity is delivered within several days, not later than one month. Much more common, however, is trading commodities through derivatives called futures. The issue of commodity futures will be explained in detail in the following chapters.|
Bond is a debt security that reflects the issuer’s obligation to the creditor. It is a substitutable security connected with the right to the payment of the outstanding amount, payment of a specified yield, and the issuer´s obligation to meet his bond-related obligations. You can buy government bonds or corporate bonds. Investments in government bonds are considered a safe investment with a low rate of return.
Table 1: Types of underlying assets
Let´s repeat once again that if we trade directly with the underlying asset (for example, if we buy stocks of a company), transactions are concluded and settled in the present moment. But we can also trade derivatives of the underlying assets. These derivative instruments are called futures contracts (fixed contracts or options) and the principle of trading them is that you conclude a transaction defining conditions of a future purchase or sale of the underlying asset. The individual types of derivative financial instruments are described in Table 2.
Table 2: Type of derivates
Finally, we must mention a separate category called Forex. Forex is an international trading system for exchange of currency pairs. Forex has no exchange and the trading is not centrally regulated. Regarding the daily volumes of transactions, however, it is without doubt the biggest and most liquid market in the world. Forex rates are mainly influenced by the relative strength, inflation, and interest rates of individual economies. The most traded currency pairs include the US dollar against the euro (USD/EUR) and the US dollar against the Japanese yen (USD/JPN).
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