ch 5 OTC Derivs Flashcards
OTC list:
more flexibility
better hedge
less liquidity
less regs
less transparency
more confidentiality
more counterparty risk
What is an OTC market?
A decentralized market for trading derivatives without a central exchange. Offers flexibility but historically lacked transparency.
How do OTC markets differ from exchanges?
OTC markets allow custom contracts but have higher counterparty risk. Exchanges use standardized contracts and have central clearing.
What are the advantages of OTC derivatives?
Customization, wide range of assets, and confidentiality. Used for hedging, speculation, and risk management.
What are the risks of OTC derivatives?
Counterparty default, liquidity issues, regulatory risk, and lack of price transparency compared to exchange-traded derivatives.
What is a forward contract?
A customized OTC agreement (future) to buy/sell an asset at a future date and fixed price. Not standardized or traded on exchanges.
What is an FX forward?
An OTC contract to exchange currencies at a future date at a predetermined rate. Used for hedging or speculation.
What is a non-deliverable forward (NDF)?
An FX forward where no physical delivery occurs, and settlement is based on the difference in exchange rates. (similar to CFD) used for speculation/hedging in restrictive country. cash settle only implied profit/loss
What is interest rate parity (IRP)?
A principle ensuring forward exchange rates reflect interest rate differentials, preventing risk-free arbitrage.
What is a currency swap?
An agreement to exchange cash flows in different currencies over time, including principal and interest payments.
What is an interest rate swap (IRS)?
A swap where parties exchange fixed and floating interest rate payments, used to manage interest rate risk.
What are the key components of an IRS?
1) Term length, 2) Notional amount, 3) Payment frequency, 4) Fixed vs floating rate.
What is a basis swap?
A swap exchanging one floating rate for another, typically based on different reference benchmarks.
What is a swaption?
An OTC option granting the right to enter an interest rate swap at a future date.
What are amortizing and accreting swaps?
Amortizing swaps reduce the notional amount over time, while accreting swaps increase it.
What is a rollercoaster swap?
A swap where the notional amount varies over time, increasing or decreasing at scheduled intervals.
What is a credit default swap (CDS)?
A contract where a buyer pays premiums for protection against a borrower’s default or credit event.
What triggers a credit default swap payout?
1) Bankruptcy, 2) Default, 3) Debt restructuring, 4) Government intervention, 5) Credit downgrade.
What is a total return swap?
A swap where one party receives the total return of an asset, while paying a fixed or floating rate.
What is an equity swap?
A type of total return swap where returns from an equity index or stock are exchanged for a fixed return.
What is an asset swap?
A bond combined with an interest rate swap, allowing investors to change fixed to floating rates or vice versa.
What is a credit-linked note (CLN)?
A debt security where repayment depends on a credit event occurring, transferring credit risk to investors.
What is an option in OTC markets?
A derivative contract giving the right, but not the obligation, to buy or sell an asset at a set price.
What is the difference between OTC and FLEX options?
OTC options are privately negotiated; FLEX options are exchange-traded but allow some customization.