underlying assets

(noun)

In finance, the underlying of a derivative is an asset, basket of assets, index, or even another derivative, such that the cash flows of the (former) derivative depend on the value of this underlying.

Related Terms

Examples of underlying assets in the following topics:

  • Overview of Derivatives

    • A derivative is a financial instrument whose value is based on one or more underlying assets.
    • A derivative is a financial instrument whose value is based on one or more underlying assets.
    • Derivatives are broadly categorized by the relationship between the underlying asset and the derivative, the type of underlying asset, the market in which they trade, and their pay-off profile.
    • The most common underlying assets include commodities, stocks, bonds, interest rates, and currencies.
    • To speculate and make a profit if the value of the underlying asset moves the way they expect.

  • Defining Options and Their Valuation

    • Options give the owner the right, but not the obligation, to buy or sell an underlying asset or instrument.
    • The first of these is the "intrinsic value," which is defined as the difference between the market value of the underlying asset and the strike price of the given option.
    • The quantity and class of the underlying asset (e.g., 100 shares of XYZ Co.
    • Where: N is the cumulative distribution function of the standard normal distribution; T - t is the time to maturity; S is the spot price of the underlying asset; K is the strike price; r is the risk free rate; and omega is the volatility of returns of the underlying asset.
    • Where: N is the cumulative distribution function of the standard normal distribution; T - t is the time to maturity; S is the spot price of the underlying asset; K is the strike price; r is the risk free rate; and omega is the volatility of returns of the underlying asset.

  • Uses of Derivatives to Manage Exposure

    • Derivatives allow risk related to the price of underlying assets, such as commodities, to be transferred from one party to another.
    • Derivatives allow risk related to the price of underlying assets, such as commodities, to be transferred from one party to another.
    • Hedging also occurs when an individual or institution buys an asset (such as a commodity, a bond that has coupon payments, a stock that pays dividends, etc.) and sells it using a futures contract.
    • The individual or institution has access to the asset for a specified amount of time and can then sell it in the future at a specified price according to the futures contract.
    • Of course, this allows the individual or institution the benefit of holding the asset, while reducing the risk that the future selling price will deviate unexpectedly from the market's current assessment of the future value of the asset.

  • Pricing a Security

    • The price of a security is the market determination of the value of the underlying asset.
    • The price of a security reflects the value of the asset underlying it.
    • It is the result of the valuation of the asset .
    • At a minimum, a solvent company could shut down operations, sell off the assets, and pay the creditors.
    • This method is known as the net asset value.

  • Reporting Assets

    • In all of these cases, the underlying value of the asset decreases over time.
    • The first is the cost of the asset.
    • This period is known as the asset's useful life.
    • To insure that the balance sheet reflects the accurate value of its assets, a business will not decrease the value of each asset as it depreciates.
    • A way an asset may become more valuable is if the business somehow enhances the asset's ability to provide services.

  • Implications for Expected Returns

    • The expected return of a diversified portfolio is the expected return of each of its underlying investments times the weight the investment receives.
    • Asset allocation is the theory that any portfolio should have a set of target weights for different asset classes based on time frame and risk tolerance.
    • Assuming rebalancing, the expected return of a diversified portfolio is simply the expected return of each of its underlying investments times the allocation weight the investment receives.
    • The theory can feature different strategies, including strategic asset allocation, tactical asset allocation, and others, but the ideas are the same as the implications for return.
    • Different returns are expected for different asset allocations given historical averages

  • Defining Finance

    • Finance is the study of fund management and asset allocation over time.
    • Finance is the study of fund management and asset allocation over time.
    • Funds consist of money and other assets.
    • The underlying driver behind all of finance is time.
    • Finance says, "Since I know assets change value over time, how do I use that to cause my assets to change value in the direction I want?

  • Reporting Intangibles

    • Intangible assets lack physical existence.
    • Unlike tangible assets such as property, plant, and equipment, intangible assets derive their value from the rights and privileges granted to the company using them.
    • Assets such as bank deposits, accounts receivable, and long-term investments in bonds and stocks lack physical substance, but are not classified as intangible assets.
    • As a result, they are normally classified as long-term assets.
    • And others argue that due to the underlying subjectivity related to intangibles, a conservative approach should be followed—that is, expense as incurred.

  • Relationships between ROA, ROE, and Growth

    • Return on assets shows how profitable a company's assets are in generating revenue.
    • Return on assets is equal to net income divided by total assets.
    • The underlying concept here is how much output can be procured from a given input (assets!).
    • Return on assets is equal to net income divided by total assets.
    • Discuss the different uses of the Return on Assets and Return on Assets ratios

  • Franchises and Licenses

    • Therefore, the value of the franchise asset equals what it cost to acquire.
    • Amortizing is a term that only applies if there is a franchise or license asset.
    • Amortization is the process of writing off the cost of an asset over its useful life.
    • The useful life of a license is how long it grants the holder the exclusive right to use the underlying product.
    • Every accounting period, the value of the asset is decreased by the amortization rate.