10- Derivatives and other instruments Flashcards
What is a Futures contract?
A Futures contract is an agreement to buy or sell a specified quantity of a specified asset on a specified future date at a price agreed today
What is a Forward contract?
An OTC Future
What is a Contingent Liability?
A contingent liability transaction describes a derivative position where the possibility of a future obligation is uncertain
What is the formula for Fair value of a future?
Fair value of future = Cash price of underlying + Costs of carry
What is cost of carry?
The benefits from holding the underlying e.g. dividends or coupon
What is the formula for basis?
Basis = Cash price - Futures price
What is Backwardation?
Where there is a greater benefit than cost to holding the asset, the fair value of the future is lower than spot price (positive basis)
What is Contango?
Where there is a greater cost than benefit to holding the asset, fair value of the future is higher than spot price (negative basis)
What is Beta?
Sensitivity of a stock relative to the market as a whole
What is the formula for contracts needed to hedge?
Fund value/(future price x tick value) x beta
What is the difference between European and American options?
American options can be exercised on any date whereas European options only on expiry
What is the maximum profit on a long call?
Infinite
What is the formula for max loss on selling a put?
(Strike x tick value) - premium
What is the formula for option premium?
Premium = Intrinsic value + Time value
What is the formula for Intrinsic value of a call?
Intrinsic value = Spot price - Strike price
Vice versa for put
When is an option ‘In the money’?
When intrinsic value is positive e.g. for a call when Spot is greater than Strike
What is the Time value of an Option?
Time value is the amount over and above the intrinsic value that an investor will pay to buy an option
What are the 4 main greeks?
- Delta
- Theta
- Vega
- Rho
What does Delta measure?
The sensitivity of on option’s premium to the spot price
What does Theta measure?
The sensitivity of on option’s premium to the time to maturity
What does Vega measure?
The sensitivity of on option’s premium to the underlying’s volatility
What does Rho measure?
The sensitivity of on option’s premium to interest rates
What is the formula for Delta?
Delta = Δoption premium/Δspot price
What are the 2 main volatility trades?
Straddles and Strangles
What is the logic behind a long volatility trade?
If you buy options and volatility rises, the premium will too and you can sell them for a profit
How is a Straddle composed?
Go long/short a call and a put at the same strike price
How is a Strangle composed?
Go long/short a call and take the same position on a put with a lower strike price
What is Tick size?
The minimum price move on the contract
What is Tick value?
The profit or loss made for a 1 tick move in the contract
What is the PnL formula for a Bond future?
PnL = No of ticks moved x Tick value x Contracts traded
What are the 5 main types of Interest rate swaps (IRS)?
-Vanilla swap: fixed for floating
-Basis swap: floating for floating
-Swaption: an option to enter into a swap
-Payer swap: agreeing to pay a fixed interest rate
-Receiver swap: agreeing to receive a fixed interest rate
How does an equity/total return swap (TRS) work?
Total return payer buys equity for direct exposure, offers this total return to a swap bank in exchange for a rate, swap bank does the same to a total return receiver
How does a Credit default swap (CDS) work?
Investor in an underlying asset can pay a swap premium to a bank in exchange for a cash payment should asset default
What is a synthetic CDO?
A CDO that is secured against the premiums on the referenced debt, rather than the referenced debt itself
What is an Unfunded credit derivative?
Where the credit protection seller makes no upfront payment e.g. CDS
What is a Funded credit derivative?
Where the credit protection seller makes an upfront payment e.g. CDO
What are 3 main advantages of the Distributed ledger?
-Produces a trustworthy and reliable record by consensus
-Prevents a single point of failure as numerous nodes are used
-Removes costs and delays
Who are the 2 main central counterparties (CCPs) in the UK?
LCH.Clearnet & ICE Clear Europe
What is Initial margin?
A returnable good faith deposit
What is Variation margin?
Daily receipts and payments of unrealised profits and losses
What is tick value?
Minimum price increment of an instrument
How are the prices of interest rate futures quoted?
100 minus an interest rate
