An artificially created security that combines a financial security (such as a bond, stock, etc) with another asset such as a different currency, an index, a warrant, derivative instrument, etc. A synthetic has the same profit-and-loss (P/L) profile as another asset or a combination of assets. That is, it mimics another asset or an asset combination in an indirect way and without having to incur significant transaction costs from holding that asset. For example, a stock can synthetically be mimicked by combining a call option with a put option. The put would have value if the underlying stock’ price moves down, while the call gains value if the stock price rises. Also, a synthetic can be created by taking a position in a futures contract together with the underlying instrument (e.g., a bond and a bond futures). Many synthetics involve transactions in different currencies so that payoffs depend on exchange rates at specific dates.
Finance
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