Book 4_Derav_READING 68_DERIVATIVE INSTRUMENT AND DERIVATIVE MARKET FEATURES

Question 1

A derivative

Answer 1

is a security that derives its value from value of another security or variable at a specific future date (the underlying)

Question 2

Basic features of a derivative

Answer 2

• the underlying,
• the price specified in the contract,
• the contract size,
• and the settlement date

Question 3

The contract price

Answer 3

• Is typically set so the contract has zero value at initiation to both parties.
• Contracts may be deliverable or cash-settled.
• Neither party pays at the initiation of the contract.

Question 4

this common rule for hedging risk with futures, which are similar to forwards:

Answer 4

“Do in the futures market what you must do in the future.”

Question 5

Exchange-traded derivatives

Answer 5

Are standardized and backed by a central clearinghouse that
- takes the opposite position to each side of a trade,
- guaranteeing the payments promised under the contract.

Question 6

Over-the-counter (OTC) derivatives

Answer 6

can be customized to fit the needs of the counterparties

Question 7

OTC markets

Answer 7

• Are largely unregulated and less transparent than exchange markets
• Some OTC markets are subject to a central clearing mandate that reduces counterparty credit risk.