Ch 1 +2 - Derivatives Flashcards

1
Q

Derivative

A

It is a contract between two parties to trade an underlying asset at a date in the future

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2
Q

Uses of derivatives

A

Hedge market risk

Speculate

Transition management

Control credit risk

Arbitrage

Synthetic index tracking

Income enhancement

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3
Q

Future

A

Is a standardised, exchange-tradable contract between two parties to trade a specified asset on a set date in the future at a specified price

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4
Q

Futures contract will typically specify

A

Unit of trading

How the settlement price is to be determined

Exact details of the underlying asset – type and quality

Delivery date

Trading hours

Form of quotation

Tick size

Method of calculating EDSP

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5
Q

Clearing party then acts as a party to every trade. Two key advantages to this:

A

Largely removes counterparty credit risk

Each contract is indistinguishable from all others (can close out positions)

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6
Q

Marked to market

A

Process of daily margin requirement changes. Reflects profits and losses

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7
Q

Open interest

A

Number of contracts outstanding at any one time

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8
Q

Role of the Clearing House:

A

Can Guarantee Real M&M’s

Counterparty to all trades

Guarantor of all deals (removing credit risk)

Registrar of deals

Holder of deposited margin

Facilitator of the marking to market process

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9
Q

Option

A

Gives an investor the right, but not the obligation, to buy/sell a specified asset on a specified future date at a set price (strike/exercise price)

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10
Q

Key differences between an Option and a Future

A

OTC (for some) vs exchange-traded

Premium

Right, but not obligation

Margin paid to clearing house by writer only

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11
Q

Fundamental differences between un-margined forward and futures contracts

A

Customised contracts vs standardised

OTC market vs exchange

More credit risk with forwards traditionally

Less marketable

Less liquid

Less transparent

Delivery of asset - traditionally physical delivery with forwards

Lack of quoted market values

Forwards require ISDA documentation

Higher dealing costs (with OTC markets)

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12
Q

Forward

A

Is a non-standardised, OTC (privately negotiated) contract between 2 parties to buy (or sell) a specified asset on a set date in the future at a specified price.

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13
Q

Types of risks associated with the use of swaps:

A

Counterparty/credit risk (principle not at stake and typically pay margin through a CCP these days)

Market risk

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14
Q

Guaranteed Equity Products

A

These offer a return linked to an equity index, but with a minimum guaranteed return, often zero

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15
Q

Structured Notes

A

Is a debt obligation (this is how it differs to a GEP) that also contains an embedded derivative component that adjusts the security’s risk and return profile

Either contain embedded options and/or provide payments that vary in some pre-specified way

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