1.1.1 Derivative Basics

Question 1

Derivative

Answer 1

Financial Instrument who’s value is determine by something else

Question 2

Underlying Asset

Answer 2

The something else that determines the derivatives value. Theoretically anything that has measurable value.

Question 3

Underlying

Answer 3

Another word for Underlying Asset

Question 4

Reasons to Use Derivative

Answer 4

1) manage risk - hedging to reduce risk
2) to speculate - making a bet based on underlying asset
3) to reduce transaction costs - can be used to achieve same outcome of trading stocks and bonds without actually buying or selling
4) minimize taxes / avoid regulatory issues - Used to defer taxes or eliminate the risk of owning an asset while still keeping the privileges

Question 5

hedging

Answer 5

purchasing a derivative in order to reduce the risk

Question 6

Who uses derivatives

Answer 6

1) End-Users - people who use derivatives
2) Market-makers - intermediaries who sell and buy derivatives to end-users in order to make a profit
3) Economic Observers - people who analyze and regulate the activities of end-users and market-makers

Question 7

Stock

Answer 7

“Common Stock” is the most common Underlying Asset for exam. Provides: ownership of company, rights to dividends and rights to vote.

Question 8

Index

Answer 8

a Statistic used to reflect the changes in a collection of stocks it tracks. different indices use different methodologies to track stocks. Possible Underlying Asset

Question 9

Commodities

Answer 9

a raw material that can be bought or sold, normally in standardized units. Possible Underlying Asset

Question 10

Currencies

Answer 10

bought and sold like commodities. Possible Underlying Asset

Question 11

Floating Currency

Answer 11

they take their value only relative to other currencies