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Underlying

Underlying

What does 'Underlying' mean

Underlying, in equities, is the common stock that must be delivered when a warrant is exercised, or when a convertible bond or convertible preferred share is converted to common stock. The price of the underlying is the main factor that determines prices of derivative securities, warrants and convertibles. Thus, a change in an underlying results in a simultaneous change in the price of the derivative asset linked to it.

Explaining 'Underlying'

There are two main types of investments: debt and equity. Debt must be paid back and investors are compensated in the form of interest payments. Equity is not required to be paid back and investors are compensated by share price appreciation or dividends. Both of these investments have specific cash flows and benefits depending on the individual investor.

Financial Derivatives

There are other financial instruments based solely on the movement of debt and equity. There are financial instruments that go up when interest rates go up. There are also financial instruments that go down when stock prices go down. These financial instruments are based on the performance of the underlying asset, or the debt and equity that is the original investment. This class of financial instrument is referred to as derivatives as it derives value from movements in the underlying. Generally, the underlying is a security such as a stock in the case of options, or a commodity in the case of futures.

An Underlying Example

Two of the most common types of derivatives are referred to as calls and puts. A call derivative contract gives the owner the right, but not the obligation, to buy a particular stock or asset at a given strike price. If company A is trading at $5 and the strike price is hit at $3, the price of the stock is trending up, the call is theoretically worth $2. In this case, the underlying is the stock priced at $5, and the derivative is the call priced at $2. A put derivative contract gives the owner the right, but not the obligation, to sell a particular stock at a given strike price. If company A is trading at $5 and the strike price is hit at $7, the price of the stock is trending down, the put is trading $2 in the money and is theoretically worth $2. In this case, the underlying is the stock priced at $5 and the derivative is the put contract priced at $2. Both the call and the put are dependent on price movements in the underlying asset, which in this case is the stock price of company A.


Further Reading

Academic research underlying industrial innovations: sources, characteristics, and financingAcademic research underlying industrial innovations: sources, characteristics, and financing
www.jstor.org [PDF]
There has been no systematic study of the characteristics of the universities and academic researchers that seem to have contributed most to industrial innovation. Nor do we know how such academic research has been funded. This paper, based on data obtained from 66 …

Bank frauds in Nigeria: Underlying causes, effects and possible remediesBank frauds in Nigeria: Underlying causes, effects and possible remedies
search.proquest.com [PDF]
There has been no systematic study of the characteristics of the universities and academic researchers that seem to have contributed most to industrial innovation. Nor do we know how such academic research has been funded. This paper, based on data obtained from 66 …

The economics of structured financeThe economics of structured finance
www.aeaweb.org [PDF]
There has been no systematic study of the characteristics of the universities and academic researchers that seem to have contributed most to industrial innovation. Nor do we know how such academic research has been funded. This paper, based on data obtained from 66 …

Density forecasting in economics and financeDensity forecasting in economics and finance
search.proquest.com [PDF]
There has been no systematic study of the characteristics of the universities and academic researchers that seem to have contributed most to industrial innovation. Nor do we know how such academic research has been funded. This paper, based on data obtained from 66 …

Thermodynamic analogies in economics and finance: instability of marketsThermodynamic analogies in economics and finance: instability of markets
www.sciencedirect.com [PDF]
There has been no systematic study of the characteristics of the universities and academic researchers that seem to have contributed most to industrial innovation. Nor do we know how such academic research has been funded. This paper, based on data obtained from 66 …

Some simple economics of crowdfundingSome simple economics of crowdfunding
www.journals.uchicago.edu [PDF]
There has been no systematic study of the characteristics of the universities and academic researchers that seem to have contributed most to industrial innovation. Nor do we know how such academic research has been funded. This paper, based on data obtained from 66 …

Handbook of Computational Finance.Handbook of Computational Finance.
125.234.102.146 [PDF]
There has been no systematic study of the characteristics of the universities and academic researchers that seem to have contributed most to industrial innovation. Nor do we know how such academic research has been funded. This paper, based on data obtained from 66 …


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