Derivatives: Forwards vs Futures

Image
  Before understanding what is derivative, let’s learn what is underlying asset. Underlying asset: Underlying asset can be real asset such as commodities, gold etc or financial assets such as index, interest rates etc. Derivatives: ·         These are financial instruments who value depend upon or is derived from some underlying asset. ·         A derivative does not have its own physical existence, it emerges out of contract between the buyer and seller of derivative instrument. ·         Its value depends upon the value of underlying asset. Hence returns from derivative instruments are linked to returns from underlying assets. ·         The most common underlying assets are stocks, bonds, commodities, market indices and currencies. ·         Derivatives are mainly used to control risks. They can be used to reduce risks (a process known as hedging) or to increase risks in order to enhance returns (speculation)   Classification of Derivatives: ·         Broadly we c

Bayesian Statistics: In a layman terms

 What is Bayesian Statistics: (I will try to explain in easy terms)

 

Often researchers investigating an unknown population parameter have information available from other sources in advance of the study that provides a strong indication of what values the parameter is likely to take. This additional information might be in a form that cannot be incorporated directly in the current study. The classical statistical approach offers no scope for the researchers to take this additional information into account. However, the Bayesian statistics is the approach which allows to take this additional information into account while estimating a population parameter.

 

Let me explain you with the help of an example:

 

4 championship races had been done between Mr. A and Mr. B. 

Out of which A has won 3 races and B has won 1 race. So, on whom are you going to bet your money in the next race?






You will Say Mr. A because P(A) = 0.75 and P(B) = 0.25

So your initial estimate about B is P(B) = 0.25

Now I will give you additional information say, there was a rain when Mr. B won and there was rain once when Mr. A won. And in the next match there will definitely be a rain.


So now I ask you again on whom will you bet your money?

Let’s decode the answer:

1.  P(R) = 0.50 (Because rain happened twice out of 4 matches)

2. P(R|B) = 1 (Because whenever Mr. B won there was a rain)

So I want to find out that what is probability that in the next race Mr. B will won if it is given that there will be a rain:

P(B|R) = P(R|B)*P(B)/P(R) = 0.50


I hope you know how this formula comes up otherwise you can mention me in comments I will tell you how.


Follow us on Linkedin: Actuary Sense

Follow us on Instagram: Actuary Sense

 

Conclusion: Initially we comes up with an answer that P(B) = 0.25 which is my prior estimate and then I give additional information about rain which we incorporated in the form of conditional probability i.e. P(R|B) = 1 and then ultimately we find P(B|R) which is my posterior probability.


So you see how with the help of Bayesian statistics I incorporated additional information into my current study and how my value changes from 0.25 to 0.50.

 

Statistics seems easy now. 😊

Its an art and you are an artist.


Follow us on Linkedin: Actuary Sense

Follow us on Instagram: Actuary Sense

 

Comments

Popular posts from this blog

Overview on Solvency II in a Layman Language - Phase 1 - Actuarial

How to perform the Asset Liability Modelling to determine Investment Strategy

Components of Solvency II in a Layman Language - Phase 2 - Actuarial