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CSC course- FIP > ch.10 > Flashcards

ch.10 Flashcards

1
Q

Derivative

A

financial contact between 2 ppl whose value derived from/dependant on, value of another asset

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2
Q

Underlying asset/security

A

financial asset (stock, bond, currency, interest ratye, futures contract, equity index) or can be a real asset or commodity (crude oil, gold, wheat)

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3
Q

2 types of derivatives

A
  1. Options

2. Forwards

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4
Q

Options

A

contract between buyer and seller
§ Buyer of option has RIGHT , not obligation to buy/sell underlying asset in future at price agree today

Seller of option is OBLIGATED to complete transaction

§ Option gives owner right to buy-Call option

§ Right to sell- Put option

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5
Q

forwards

A

contracts between buyer/seller
§ Both OBLIGATED to trade underlying asset in future at price agreed on today

§ Neither party has given other any right, both MUST participate

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6
Q

Forwards features

A

○ No upfront money req

○ Both parties may make a “performance bond” “ good faith deposit”

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7
Q

Options features

A

○ Buyer makes pmt when contract drawn up- Premium

○ Premium gives buyer right to buy/sell asset at preset price before expires

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8
Q

exchg traded vs OTC derivatives– flexibility/standardization

A

○ In OTC market, terms/conditions can be customzed for OTC.

○ Exchange traded derivatives, contracts are standardized, cannot customize

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9
Q

excchag traded vs otc der.- privacyb

A

○ OTC derivative transaction, neither public nor others know about transaction

Exchanges: all transactions recorded and known to public

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10
Q

exchg traded vs OTC derivatives- Liquidity/offsetting

A

Otc derivatives cannot be easily terminated or trf to other parties in secondary market

Exchange traded derivatives- can be terminated easily b/c standardizzed and public

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11
Q

exchng traded vs OTC derivatives- Defaukt risk

A

○ Downside b/c OTC private

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12
Q

default risk

A

risk one person in contract cannot meet obligation

○ b/c of this risk, dealers do not deal w/ customers that are not credit worthy

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13
Q

Canadian Derivatives Clearing Corp (CDCC)

A

responsible for clearing Montreal exchange futures, and option trades and ICE clear Canada clears ICE futures Canada trades

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14
Q

exchg traded vs OTC derivatives- Regulation

A

○ OTC contracts are private and exchange traded contracts public
○ OTC generally unregulated

exchg traded - regulated

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15
Q

types of underlying assets

A

Commodities

financial assets

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16
Q

Commodities

A

• Commonly used by producers, merchandisers, processors of commodities to protect against fluctuating commodity prices (soy beans, crude oil, copper, gold)

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17
Q

Financials

A

Equities
Interest rates
currencies

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18
Q

users of derivatives

A

○ Individual Investors
○ Institutional investors
○ Businesses/Corporations

Derivatives dealers

use derivatives to speculate on price/value of underlying asset or to protect value of anticipated/existing position

19
Q

Individual investors

A

Able to trade exchange traded derivatives only

active investors in exchnage traded options markets and futures market

Speculative strategies only in have high degree of risk tolerance, b/c potential large loss

20
Q

Institutional Investors

A
  • Incl mutual fund managers, hedge fund managers, pension fund managers, insurance companies, etc
    • Use derivatives to speculate and risk management

other uses for derivatives

  • market entry/exit
  • yield enhancement
  • arbitrage
21
Q

Hedging

A

attempt to eliminate/reduce risk of holding asset for future sale/anticiaptinf future purchase of asset

22
Q

market entry/exit

A

quickly exiting/entering market in conventional way- buying/selling stocks- is expensive

23
Q

Yield enhancement

A

investment strategy used to boost returns on underlying investment portfolio

24
Q

Arbitrage

A

same asset/commodity traded in different prices in 2 separate markets

25
Q

What are options

A

• Option is contract between 2 parties , buyer (long position/holder), and Seller (short position/writer)

  • Buyer has right , but not obligated
  • Seller OBLIGATED to sell
    • Gives holder right to buy, Writer obligation to sell= Call option
    • Gives holder right to sell, writer obligation to pay = put option
26
Q

Strike price (exercise price)

A

price at which underlying asset can be purchased/sold in future

27
Q

Option premium

A

to obtain right to buy/sell underlying asset, option buyers must pay sellers a fee

28
Q

expiration date

A

expires at specific/ pre established dates

	○ Options listd with relativeley short terms (8mths or less)
29
Q

Trading unit

A

describes size or amount of underlying asset represented by one option contract

Premium of option always listed on per unit basis

		§ To calculate total premium: premium quote X options trading unit
30
Q

American style options

A

can be exercised at any time up to and incl expiration date

31
Q

European style options

A

option can be exercised only on expiration date

32
Q

LEAPS (Long term equity AnticiPation Securities

A

long term option contracts, offer same risks and reward as regular options

33
Q

Rights:

A

privilege granted to existing shareholder to acquire additional shares directly from issuing company

• No cost for shareholders to acquire rights

Exercise price of right= subscription or offering price

34
Q

Record date

A

to determine list of shareholder that will receive the rights

	○ c/s already in record books on record date receive rights
35
Q

Ex rights

A

anyone buying shares at this time does not get the rights

36
Q

Cum rights

A

-anyone who buys the stock entitled to receive rights if they hold sock until at least record date

Between day of announcement/record date and ex-rights date= Cum rights

37
Q

Rights holder 4 options

A

○ Exercie some/all rights and acquire shares
○ Sell some/all rights
○ Buy more rights to trade, exercise later
○ Do nothing, rights expire– no benefit

38
Q

trading price of a right

A

intrinsic value + Time value

39
Q

Intrinsic value of right during ex- right

A
  • 2 business days before record date, shares trade ex rights
    • Intrinsic value of right during ex- right = S - X / n○ s= market price of stock
      ○ x= exercise/sub price of rights
      ○ n= number of rights needed to buy 1 share
40
Q

Intrinsic value of rights during cum right period

A

• Intrinsic value of rights during cum right period=

s-x / n + i

41
Q

Regular delivery

A

Canadian trading requires rights transaction be settled by 3rd business day after transaction

42
Q

Warrant

A

security that gives holder the right to buy shares in company from issuer at set price for set period of time

  • • BUT warrants issued by company itslef (options issued by other investors)
43
Q

Intrinsic value

A

amount by which market price of underlying C/S exceeds exercise price of the warrant

44
Q

Time value

A

amount by which the market price of warrant exceeds intrinsic value

CSC course- FIP (11 decks)

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