Alternative Investments

Alternative investments usually refer to a set of assets which are separate from the traditional asset classes. The concept of alternative investments is relatively new and includes a range of financial instruments most commonly – derivatives, hedge funds and mutual funds. Mutual funds have become a mainstay in the range of financial instruments on offer in Jamaica. However, while other alternative investments may be in use, they are not as common.

Derivatives

These are financial instruments whose value depends on changes in the value of one or more underlying assets – more often commodities, stocks , currencies or bonds. Derivatives typically take the form of four types of contracts which may be between two or more parties. These contracts are:

Forward: This contract is an agreement negotiated at a current date between a buyer and a seller for an asset to be traded at a specific future time, in a specific amount and at a predetermined price.

Futures: This is the same as a forward contract except that it is traded in the secondary market on an Exchange and is therefore more standardized in structure so as to facilitate ease of transactions.

Options: An options contract gives the holder the right but not the legal obligation to buy or sell an asset at a predetermined price. This may be a call or a put option. The former is an option to buy an asset and the latter, an option to sell an asset.

Call option:   Whereas in a forward or futures contract, the parties are given the right and legal obligation to trade specified assets, this options contract allows the buyer only the right to purchase. If the buyer chooses to purchase the asset, the seller has the legal obligation to deliver the asset at a specified time and price.

Put option:  This contract allows the seller only the right to sell. If the seller chooses to sell the asset, the buyer has the legal obligation to purchase the asset at a specified time and price.

Swaps: This is a derivative contract whereby the parties agree to trade cash overtime based on some predetermined conditions. The conditions stipulate what will be used to determine the exchange of cash overtime. Most often, interest rate, stock price, commodity price or the exchange rate is used.

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Hedge Funds

These are securities that are traded using investment strategies which are very aggressive and characterized mainly by trades on public Exchanges. They are considered to be based on speculation, with huge bets made on movements usually in the currency, stock and bond markets.

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