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.

  • Other Considerations in Capital Budgeting

    • The notion of real options was developed from the idea that one can view firms' discretionary investment opportunities as a call option on real assets, in much the same way as a financial call option provides decision rights on financial assets.
    • A simple financial option gives its holder the right, but not the obligation, to buy or sell a specified quantity of an underlying asset at a specified price at or before a specified date.
    • The option is "real" because the underlying assets are usually physical and human assets rather than financial securities.
    • The commonality in applying option-pricing models for real assets and for financial securities is that the future is uncertain.
    • The abandonment options comes into play when a firm purchases an asset that it may later resell or put to an alternative use, should future conditions be sufficiently adverse.

  • Types of Exchange Hedges: Forward, Money Market, and Future

    • In finance, a forward contract, or simply a forward, is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today.
    • The party agreeing to buy the underlying assets in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position.
    • In many cases, the underlying asset to a futures contract may not be traditional commodities at all – that is, for financial futures the underlying item can be any financial instrument (including currency, bonds, and stocks).
    • The party agreeing to buy the underlying asset in the future, the buyer of the contract, is said to be long, and the party agreeing to sell the asset in the future, the seller of the contract, is said to be short.
    • Forward contracts are very similar to futures contracts, except they are not exchange-traded, or defined on standardized assets.

  • 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.

  • Overview of Warrants

    • A warrant is exercised when the holder informs the issuer of their intention to purchase the shares underlying the warrant.
    • While each option contract is generally over 1,000 underlying ordinary shares, the number of warrants that must be exercised by the holder to buy the underlying asset depends on the conversion ratio set out in the offer documentation for the warrant issue.
    • Intrinsic value: This is simply the difference between the exercise (strike) price and the underlying stock price.
    • Warrants are also referred to as in-the-money or out-of-the-money, depending on where the current asset price is in relation to the warrant's exercise price.
    • In other words, the writer of a traditional warrant is also the issuer of the underlying instrument.

  • 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?

  • 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