Question

Foundations of Financial Management: Define and discuss the following types of financial derivatives- futures, mortgage backed securities

Answer 1

Futures means those  derivative financial contracts which obligate the parties to contract to transact an security at a predetermined future date and price decided today . Here, the purchaser must purchase or the seller must sell the underlying security at the price, irrespective of the current market price at the date of expiry.

Underlying assets may include physical commodities or other instruments. Futures contracts includes the detail of the quantity of the underlying asset and are standardized to facilitate trading on a futures stock exchange. It can be used to hedge or trade speculation.

Mortgage-backed securities are those investments which are secured by mortgages. They’re backed by asset. A security is an investment which is being traded on a secondary market. It allows investors to gain benefit from the mortgage business without having to buy or sell an actual house loan. Typically the  buyers of these securities are

institutional

corporate

individual investors.

First step:- , a bank lends a home loan. Then the  bank then sells that loan to an bank. It uses the money received from the investment bank to make another loans.

The investment bank adds the house loan to other bundle of mortgages with similar interest rates. It accumulates the bundle in a special company designed It's called a Special Purpose Vehicle . That helps to keep the mortgage-backed securities separate from the bank's different services. The SPV then markets the mortgage-backed securities.