Chap 10 : Derivatives Flashcards
A financial contract between two parties whose value is derived from, or dependent on, the value of an underlying asset.
Derivative
With _________ contracts, both parties oblige themselves to trade the underlying asset in the future at a price agreed upon today.
Forward
With _______, no upfront payment is required.
Forwards
A payment which gives the party on the other side of the transaction a higher level of assurance that the terms of the forward will be honoured.
Performance bond or good-faith deposit
With ______, the buyer makes a payment to the seller when the contract is drawn up. This payment, known as the premium, gives the buyer the right to buy or sell the underlying asset at a pre-set price on or before the expiration date.
Options
Another feature of derivatives is that, unlike financial assets such as stocks and bonds, they are considered ___________. the gain from an option or forward contract by one counterparty is exactly offset by the loss to the other counterparty. In other words, every dollar gained by one party represents a dollar lost by the counterparty.
zero-sum game
Most bonds trade in the _________ market
over-the-counter
Stocks and derivatives trade both on the _________ market and in __________
OTC
Organized exchanges
One of the attractive features of OTC derivatives to the corporations and institutional investors that use them is that contracts can be …………..
custom designed to meet specific needs
The derivatives exchange
Montreal Exchange
Another downside to the private nature of OTC derivatives is that __________ (also know as credit risk) is a major concern
default risk
____________, which are set up by exchanges to ensure that markets operate efficiently, guarantee the financial obligations of every party and contract.
Clearinghouses
The ___________ is responsible for clearing Montreal Exchange futures and option trades.
Canadian Derivatives Clearing Corporation
derivative transactions on exchanges are extensively regulated by ___________
the exchanges themselves and by gov’t agencies
OTC derivative transactions are…….
generally unregulated
Gains and losses accrue on a day-to-day basis is known as _______
Marking to Market
The two general categories of underlying assets for derivative contracts are _______- and _______.
Commodities and Financial Assets
___________ and options are commonly used by producers, merchandisers, and processors of commodities to protect themselves against fluctuating commodity prices.
Commodity Futures
A __________ opportunity refers to a scenario where the same asset or commodity is traded at different prices in two separate markets. By purchasing low in one market and selling high in the other market simultaneously, an investor locks in a fixed amount of profit at no risk
Arbitrage
_____________ is a method of boosting returns on an underlying investment portfolio by taking a speculative position based on expectations of future market movements. The most popular way to enhance an investment’s yield is by selling options against the position.
Yield Enhancement
An option that gives its holder the right to buy, and the seller the obligation to sell, the underlying asset is known as a _________
Call Option
An option that gives the holder the right to sell, and its writer the obligation to buy, the underlying asset is referred to as a _________
Put Option
_______________is the price at which the underlying asset can be purchased or sold in the future. The buyer and the seller agree on this future price when they enter into the option contract
The Strike price or Exercise Price
To obtain the right to buy or sell the underlying asset, option buyers must pay the sellers a fee, known as the ………
option premium
___________ style options can be exercised at any time, up to and including the expiration date.
American
_______style options can be exercised only on the expiration date.
European
A ________________ is simply a long-term option contract offering the same risks and rewards as a regular option
Long-term equity anticipation security
A ___________ transaction occurs when an investor establishes a new positon in an option contract.
Opening
Positions may be liquidated prior to expiration by way of an……..
offsetting transaction
The party of the long position will exercise the option. When this happens, the party holding the short position is said to be _______ on the option
Assigned
Owners of options will exercise only if it is in their best financial interest, which can only occur when an option is ____________
in-the-money
Owners of options will not exercise if they are __________-
out of the money or at the money
___________ is the value of certainty
Intrinsic Value
If an option is not in-the-money, it has ___________ value
zero intrinsic value
__________ are bought to establish a maximum purchase price for the stock, or to limit the potential losses on a short position in the stock. In this sense, options act much like insurance by protecting the buyer when the stock price moves higher
Call options
___________ writers own the underlying stock, and use this position to meet their obligations, if they are assigned.
Covered Call
_________writers do not own the underlying stock
Naked Call
When a forward is traded on an exchange, it is called a _____________
Futures Contract
_______ can trade on an exchange or OTC markets
Forwards
When a forward is traded OTC, it is generally referred to as a……..
Forward Agreement
Many financial futures are based on underlying assets that are difficult or even impossible to deliver. For those types of futures, delivery involves an exchange of cash from one party to the other. The amount is based on the performance of the underlying asset from the time the future was entered into until the time that it expires. These futures are known as _________
Cash Settled Futures Contracts
Like call options, ______ and _______ are securities that give their owners the rights, but not the obligation, to buy a specific amount of stock at a specified price on or before the expiration date.
Rights and Warrants
Rights and Warrants are usually issued by a ______ as a method of raising capital.
Company
_____ are usually short term, with the expiration date often as little as four to six weeks after they are issued
Rights
______ tend to be issued with three to five years to expiration
Warrants
A _______ is a privilege granted to an existing shareholder to acquire additional shares directly from the issuing company.
Right
The exercise price of a right, known as the ______ price or ________ price, is the price shareholders pay to purchase additional shares of the company. The offering price is almost always lower than the market price of the shares at the time that their rights are issued. This discount makes the rights valuable and gives shareholders an incentive to exercise them.
Subscription or Offering price
As with options, the trading price of a right is equal to the ____________, if any, plus the time value.
Intrinsic Value
You have to add +1 to the denominator of the Intrinsic Value of Rights equation during the __________ period, when the rights are imbedded in the common stock.
Cum Rights
A ________ is a security that gives its holders the right to buy shares in a company from the issuer at a set price by a set period of time
Warrant
Warrants are like call options. The main difference is……..
Warrants are issued by the company itself, whereas call options are issued by other investors.
Warrants are often issued as part of a package that also contains a new debt or preferred share issue. The warrants help make these issues more attractive to buyers by giving them the opportunity to participate in any appreciation of the issuer’s common shares. In other words, they function like, and are known, as a _________.
Sweetener
The predominant type of Forward Agreements are based on _______ and _______
Interest Rates and Currencies
If the put writer had set aside an amount of cash equal to the purchase value of the stock if assigned, the strategy is known as a…..
cash-secured put write
