Thursday, August 03, 2006

Financial Contracts

The basis of finance is to bind contractual relationships between people. These contractual relationships can be as example:

  • "renting" money (loans, bonds)
  • buying a property share of a company's profits and voting rights (stocks)
  • paying someone to protect us against some risk (options, insurances, credit derivatives)
  • pre-arranging availability of money for a given rate (Interest Rate Futures)
  • ...

These financial contracts (or instruments) share some common properties, they have:

  • a price
  • an owner
  • a counterparty on the other hand of the contract
  • a date of origination

A convenient way to see financial contracts or instruments is to see them as streams of cash-flows, i.e. a certain number of certain or contingent money exchanges between the counterparties. These cash-flows always happen on pre-arranged terms which are the contractual conditions.

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