Abcs of CROSS-BORDER DERIVATIVES©
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Section 1256 and Foreign Currency Derivatives
Section 1256 and Foreign Currency Derivatives Viva Hammer1 Mark-to-market taxation was considered “a fundamental departure from the concept of income realization in the U.S. tax law”2 when it was introduced in 1981. Congress was only game to propose the concept because of rampant “straddle” shelters that were undermining the U.S. tax system and commodities derivatives markets. Early in tax history, the Supreme Court articulated the realization principle as a Constitutional limitation on Congress’ taxing power. But in 1981, lawmakers makers felt confident imposing mark-to-market on exchange traded futures contracts because of the exchanges’ system of variation margin. However, when in 1982 non-exchange foreign currency traders asked to come within the ambit of mark-to-market taxation, Congress acceded to their demands even though this market had no equivalent to variation margin. This opportunistic rather than policy-driven history has spawned a great debate amongst tax practitioners as to the scope of the mark-to-market rule governing foreign currency contracts. Several recent cases have added fuel to the debate. The Straddle Shelters of the 1970s Straddle shelters were developed to exploit several structural flaws in the U.S. tax system: (1) the vast gulf between ordinary income tax rate (maximum 70%) and long term capital gain rate (28%), (2) the arbitrary distinction between capital gain and ordinary income, making it relatively easy to convert one to the other, and (3) the non- economic tax treatment of derivative contracts. Straddle shelters were so pervasive that in 1978 it was estimated that more than 75% of the open interest in silver futures were entered into to accommodate tax straddles and demand for U.S. -
How Much Do Banks Use Credit Derivatives to Reduce Risk?
How much do banks use credit derivatives to reduce risk? Bernadette A. Minton, René Stulz, and Rohan Williamson* June 2006 This paper examines the use of credit derivatives by US bank holding companies from 1999 to 2003 with assets in excess of one billion dollars. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2003 only 19 large banks out of 345 use credit derivatives. Though few banks use credit derivatives, the assets of these banks represent on average two thirds of the assets of bank holding companies with assets in excess of $1 billion. To the extent that banks have positions in credit derivatives, they tend to be used more for dealer activities than for hedging activities. Nevertheless, a majority of the banks that use credit derivative are net buyers of credit protection. Banks are more likely to be net protection buyers if they engage in asset securitization, originate foreign loans, and have lower capital ratios. The likelihood of a bank being a net protection buyer is positively related to the percentage of commercial and industrial loans in a bank’s loan portfolio and negatively or not related to other types of bank loans. The use of credit derivatives by banks is limited because adverse selection and moral hazard problems make the market for credit derivatives illiquid for the typical credit exposures of banks. *Respectively, Associate Professor, The Ohio State University; Everett D. Reese Chair of Banking and Monetary Economics, The Ohio State University and NBER; and Associate Professor, Georgetown University. We are grateful to Jim O’Brien and Mark Carey for discussions. -
Faqs on Straddle Contracts – Currency Derivatives
FAQs on Straddle Contracts FAQs on Straddle Contracts – Currency Derivatives 1. What is meant by a Straddle Contract? Straddle contracts are specialised two-legged option contracts that allow a trader to take positions on two different option contracts belonging to the same product, at the same strike price and having the same expiry. 2. What are the components of a Straddle contract? A straddle contract comprises of two individual legs, the first being the call option leg and the second being the put option leg, having same strike price and expiry. 3. In which segment will Straddle contracts be offered? To start with, straddle contracts will be offered in the Currency Derivatives segment. 4. What will be the market lot of the straddle contract? Market lot of a straddle contract will be the same as that of its corresponding individual legs i.e. the market lot of the call option leg and the put option leg. 5. What will be the tick size of the straddle contract? Tick size of a straddle contract will be the same as that of its corresponding individual legs i.e. the tick size of the call option leg and the put option leg. 6. For which expiries will straddle contracts be made available? Straddle contracts will be made available on all existing individual option contracts - current, near, & far monthly as well as quarterly and half yearly option contracts. 7. How many in-the-money, at-the-money and out-of-the-money contracts will be available? Minimum two In-the-Money, two Out-of-the-Money and one At-the-Money straddle contracts will be made available. -
307439 Ferdig Master Thesis
Master's Thesis Using Derivatives And Structured Products To Enhance Investment Performance In A Low-Yielding Environment - COPENHAGEN BUSINESS SCHOOL - MSc Finance And Investments Maria Gjelsvik Berg P˚al-AndreasIversen Supervisor: Søren Plesner Date Of Submission: 28.04.2017 Characters (Ink. Space): 189.349 Pages: 114 ABSTRACT This paper provides an investigation of retail investors' possibility to enhance their investment performance in a low-yielding environment by using derivatives. The current low-yielding financial market makes safe investments in traditional vehicles, such as money market funds and safe bonds, close to zero- or even negative-yielding. Some retail investors are therefore in need of alternative investment vehicles that can enhance their performance. By conducting Monte Carlo simulations and difference in mean testing, we test for enhancement in performance for investors using option strategies, relative to investors investing in the S&P 500 index. This paper contributes to previous papers by emphasizing the downside risk and asymmetry in return distributions to a larger extent. We find several option strategies to outperform the benchmark, implying that performance enhancement is achievable by trading derivatives. The result is however strongly dependent on the investors' ability to choose the right option strategy, both in terms of correctly anticipated market movements and the net premium received or paid to enter the strategy. 1 Contents Chapter 1 - Introduction4 Problem Statement................................6 Methodology...................................7 Limitations....................................7 Literature Review.................................8 Structure..................................... 12 Chapter 2 - Theory 14 Low-Yielding Environment............................ 14 How Are People Affected By A Low-Yield Environment?........ 16 Low-Yield Environment's Impact On The Stock Market........ -
Tax Treatment of Derivatives
United States Viva Hammer* Tax Treatment of Derivatives 1. Introduction instruments, as well as principles of general applicability. Often, the nature of the derivative instrument will dictate The US federal income taxation of derivative instruments whether it is taxed as a capital asset or an ordinary asset is determined under numerous tax rules set forth in the US (see discussion of section 1256 contracts, below). In other tax code, the regulations thereunder (and supplemented instances, the nature of the taxpayer will dictate whether it by various forms of published and unpublished guidance is taxed as a capital asset or an ordinary asset (see discus- from the US tax authorities and by the case law).1 These tax sion of dealers versus traders, below). rules dictate the US federal income taxation of derivative instruments without regard to applicable accounting rules. Generally, the starting point will be to determine whether the instrument is a “capital asset” or an “ordinary asset” The tax rules applicable to derivative instruments have in the hands of the taxpayer. Section 1221 defines “capital developed over time in piecemeal fashion. There are no assets” by exclusion – unless an asset falls within one of general principles governing the taxation of derivatives eight enumerated exceptions, it is viewed as a capital asset. in the United States. Every transaction must be examined Exceptions to capital asset treatment relevant to taxpayers in light of these piecemeal rules. Key considerations for transacting in derivative instruments include the excep- issuers and holders of derivative instruments under US tions for (1) hedging transactions3 and (2) “commodities tax principles will include the character of income, gain, derivative financial instruments” held by a “commodities loss and deduction related to the instrument (ordinary derivatives dealer”.4 vs. -
Credit Derivative Handbook 2003 – 16 April 2003
16 April 2003 Credit Derivative CREDIT Chris Francis (44) 20 7995-4445 [email protected] Handbook 2003 Atish Kakodkar (44) 20 7995-8542 A Guide to Products, Valuation, Strategies and Risks [email protected] Barnaby Martin (44) 20 7995-0458 [email protected] Europe The Key Piece In The Puzzle V ol a Risk til t ity Managemen rate rpo Co ds Bon Capital Structure CreditCredit DerivativesDerivatives Arbitrage F irst D To efa dit ult Cre ed Link tes No Convertible Bonds Derivatives Refer to important disclosures at the end of this report. Merrill Lynch Global Securities Research & Economics Group Investors should assume that Merrill Lynch is Global Fundamental Equity Research Department seeking or will seek investment banking or other business relationships with the companies in this report. RC#60910601 Credit Derivative Handbook 2003 – 16 April 2003 CONTENTS n Section Page Market Evolution: Going 1. Market growth, importance and prospects 3 Mainstream? Credit Default Swap Basics 2. The basic concepts 10 Valuation of Credit Default 3. Arbitrage relationship and an introduction to survival probabilities 13 Swaps Unwinding Default Swaps 4. Mechanics for terminating contracts 19 Valuing the CDS Basis 5. Comparing CDS with the cash market 29 What Drives the Basis? 6. Why do cash and default market yields diverge? 35 CDS Investor Strategies 7. Using CDS to enhance returns 44 CDS Structural Roadmap 8. Key structural considerations 60 What Price Restructuring? 9. How to value the Restructuring Credit Event 73 First-to-Default Baskets 10. A guide to usage and valuation 84 Synthetic CDO Valuation 11. Mechanics and investment rationale 95 Counterparty Risk 12. -
International Harmonization of Reporting for Financial Securities
International Harmonization of Reporting for Financial Securities Authors Dr. Jiri Strouhal Dr. Carmen Bonaci Editor Prof. Nikos Mastorakis Published by WSEAS Press ISBN: 9781-61804-008-4 www.wseas.org International Harmonization of Reporting for Financial Securities Published by WSEAS Press www.wseas.org Copyright © 2011, by WSEAS Press All the copyright of the present book belongs to the World Scientific and Engineering Academy and Society Press. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the Editor of World Scientific and Engineering Academy and Society Press. All papers of the present volume were peer reviewed by two independent reviewers. Acceptance was granted when both reviewers' recommendations were positive. See also: http://www.worldses.org/review/index.html ISBN: 9781-61804-008-4 World Scientific and Engineering Academy and Society Preface Dear readers, This publication is devoted to problems of financial reporting for financial instruments. This branch is among academicians and practitioners widely discussed topic. It is mainly caused due to current developments in financial engineering, while accounting standard setters still lag. Moreover measurement based on fair value approach – popular phenomenon of last decades – brings to accounting entities considerable problems. The text is clearly divided into four chapters. The introductory part is devoted to the theoretical background for the measurement and reporting of financial securities and derivative contracts. The second chapter focuses on reporting of equity and debt securities. There are outlined the theoretical bases for the measurement, and accounting treatment for selected portfolios of financial securities. -
Straddles and Strangles to Help Manage Stock Events
Webinar Presentation Using Straddles and Strangles to Help Manage Stock Events Presented by Trading Strategy Desk 1 Fidelity Brokerage Services LLC ("FBS"), Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917 690099.3.0 Disclosures Options’ trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options, and call 800-544- 5115 to be approved for options trading. Supporting documentation for any claims, if applicable, will be furnished upon request. Examples in this presentation do not include transaction costs (commissions, margin interest, fees) or tax implications, but they should be considered prior to entering into any transactions. The information in this presentation, including examples using actual securities and price data, is strictly for illustrative and educational purposes only and is not to be construed as an endorsement, or recommendation. 2 Disclosures (cont.) Greeks are mathematical calculations used to determine the effect of various factors on options. Active Trader Pro PlatformsSM is available to customers trading 36 times or more in a rolling 12-month period; customers who trade 120 times or more have access to Recognia anticipated events and Elliott Wave analysis. Technical analysis focuses on market action — specifically, volume and price. Technical analysis is only one approach to analyzing stocks. When considering which stocks to buy or sell, you should use the approach that you're most comfortable with. As with all your investments, you must make your own determination as to whether an investment in any particular security or securities is right for you based on your investment objectives, risk tolerance, and financial situation. -
Form 6781 Contracts and Straddles ▶ Go to for the Latest Information
Gains and Losses From Section 1256 OMB No. 1545-0644 Form 6781 Contracts and Straddles ▶ Go to www.irs.gov/Form6781 for the latest information. 2020 Department of the Treasury Attachment Internal Revenue Service ▶ Attach to your tax return. Sequence No. 82 Name(s) shown on tax return Identifying number Check all applicable boxes. A Mixed straddle election C Mixed straddle account election See instructions. B Straddle-by-straddle identification election D Net section 1256 contracts loss election Part I Section 1256 Contracts Marked to Market (a) Identification of account (b) (Loss) (c) Gain 1 2 Add the amounts on line 1 in columns (b) and (c) . 2 ( ) 3 Net gain or (loss). Combine line 2, columns (b) and (c) . 3 4 Form 1099-B adjustments. See instructions and attach statement . 4 5 Combine lines 3 and 4 . 5 Note: If line 5 shows a net gain, skip line 6 and enter the gain on line 7. Partnerships and S corporations, see instructions. 6 If you have a net section 1256 contracts loss and checked box D above, enter the amount of loss to be carried back. Enter the loss as a positive number. If you didn’t check box D, enter -0- . 6 7 Combine lines 5 and 6 . 7 8 Short-term capital gain or (loss). Multiply line 7 by 40% (0.40). Enter here and include on line 4 of Schedule D or on Form 8949. See instructions . 8 9 Long-term capital gain or (loss). Multiply line 7 by 60% (0.60). Enter here and include on line 11 of Schedule D or on Form 8949. -
Long Straddle Strategy to Hedge Uncertainty
International Journal of Research in Finance and Marketing (IJRFM) Available online at : http://euroasiapub.org/current.php?title=IJRFM Vol. 7 Issue 1, January - 2017, pp. 136~148 ISSN(o): 2231-5985 | Impact Factor: 6.397 | Thomson Reuters Researcher ID: L-5236-2015 LONG STRADDLE STRATEGY TO HEDGE UNCERTAINTY Dr. Thangjam Ravichandra Assistant Professor & Coordinator Department of Professional Studies Christ University, Bangalore, India ABSTRACT This paper examines the use of Long Straddle as a strategy to hedge risk and yield maximum return as opposed to trading in pure options and trading in equity stocks. Our analysis is based on the Long Straddle created for three different well established companies which are Mindtree, TCS and Infosys. The purpose of the paper is to bring out the benefits of using the strategy and comparing it with pure options trading and equity stock trading. The long straddle is a way to profit from increased volatility or sharp move in the underlying stock’s price so as to maximize the return of the investor. The research paper is done solely for the purpose of investments in options. Key words: Hedge, Risk & Return, Long Straddle, Options, Equity Stocks, Volatility . International Journal of Research in Finance & Marketing Email:- [email protected], http://www.euroasiapub.org 136 An open access scholarly, peer-reviewed, interdisciplinary, monthly, and fully refereed journal International Journal of Research in Finance and Marketing (IJRFM) Vol. 7 Issue 1, January - 2017 ISSN(o): 2231-5985 | Impact Factor: 6.397 | 1. INTRODUCTION Options allow investors and traders to make money in ways that are not possible simply by buying or selling the underlying security. -
Credit Derivatives
3 Credit Derivatives CHAPTER 7 Credit derivatives Collaterized debt obligation Credit default swap Credit spread options Credit linked notes Risks in credit derivatives Credit Derivatives •A credit derivative is a financial instrument whose value is determined by the default risk of the principal asset. •Financial assets like forward, options and swaps form a part of Credit derivatives •Borrowers can default and the lender will need protection against such default and in reality, a credit derivative is a way to insure such losses Credit Derivatives •Credit default swaps (CDS), total return swap, credit default swap options, collateralized debt obligations (CDO) and credit spread forwards are some examples of credit derivatives •The credit quality of the borrower as well as the third party plays an important role in determining the credit derivative’s value Credit Derivatives •Credit derivatives are fundamentally divided into two categories: funded credit derivatives and unfunded credit derivatives. •There is a contract between both the parties stating the responsibility of each party with regard to its payment without resorting to any asset class Credit Derivatives •The level of risk differs in different cases depending on the third party and a fee is decided based on the appropriate risk level by both the parties. •Financial assets like forward, options and swaps form a part of Credit derivatives •The price for these instruments changes with change in the credit risk of agents such as investors and government Credit derivatives Collaterized debt obligation Credit default swap Credit spread options Credit linked notes Risks in credit derivatives Collaterized Debt obligation •CDOs or Collateralized Debt Obligation are financial instruments that banks and other financial institutions use to repackage individual loans into a product sold to investors on the secondary market. -
Credit Derivatives: Capital Requirements and Strategic Contracting∗
Credit Derivatives: Capital Requirements and Strategic Contracting∗ Antonio Nicol`o Loriana Pelizzon Department of Economics Department of Economics University of Padova University of Venice and SSAV [email protected] [email protected] Abstract How do non-publicly observable credit derivatives affect the design contracts that buyers may offer to signal their own types? When credit derivative contracts are private, how do the different rules of capital adequacy affect these contracts? In this paper we address these issues and show that, under Basel I, high-quality banks can use CDO contracts to signal their own type, even when credit derivatives are private contracts. However, with the introduction of Basel II the presence of private credit derivative contracts prevents the use of CDO as signalling device if the cost of capital is large. We also show that a menu of contracts based on a basket of loans characterized by different maturities and a credit default swap conditioned on the default of the short term loans can be used as a signalling device. Moreover, this last menu generates larger profits for high-quality banks than the CDO contract if the cost of capital and the loan interest rates are sufficiently high. JEL Classification: G21, D82 Keywords: Credit derivatives, Signalling contracts, Capital requirements. ∗We gratefully acknowledge conversations with Franklin Allen, Viral Acharya, Andrea Beltratti, Mark Carey, Ottorino Chillemi, Francesco Corielli, Marcello Esposito, Mark Flannery, Anke Gerber, Michel Gordy, Gary Gorton, Piero Gottardi, John Hull, Patricia Jackson, Fabio Manenti, Giovanna Nicodano, Bruno Parigi, Stephen Schaefer, Walter Torous, Elu vonThadden, Guglielmo Weber, seminar audiences at University of Padua, University of Bologna seminars and participants at Centro Baffi Workshop, Milan, EFMA 2004, Basel, La Sapienza University Workshop, Rome, CERF Conference on Financial Innovation, Cambridge, FMA 2005, Siena, CREDIT 2005, Venice.