Chapter 10 Flashcards
What are the characteristics of OTC derivatives market?
Lightly regulated, dominated by financial institutions, no regular trading hours, open nights, weekend and holidays, contracts can be custom to meet specific needs and can be more complex than exchange traded derivates.
What are the cahracteristics of exchange-traded derivates?
Provides facilities for trading: trading floor or electronic trading system, exchange stipulated rules and regulations, more liquid and less default risk. The Montreal exchange is the only derivative exchange.
What is hedging?
form of risk management to protect an existing position int he underlying asset.
What are derivate dealers and what role do they play in OTC market?
They are market makers that stand ready to buy/sell contracts. They take the other side of the positions entered into by end users. They are the chartered banks, their investment dealer subsidiaries and the large foreign banks and investment dealers
What is call vs put option?
Call: right to buy
put: right to sell
Who is long and who is short when trading options? (buyer vs seller)
buyer is in a long position
seller is in a short position
What is american style option
Can be exercised at any time, up to and including the expiration date. All exchange-traded stock options in NA are american-style
what is European style option
Can be exercised only on the expiration date. Mostindex options are European style
What is a long-term equity anticipation securities
long-term option oferring same risk and rewards and regular options
What is opening transations vs offsetting transaction?
opening: investor establishes new position in an option contract
offsetting: position is liquidated prior to expiration by offsetting the position, essentially cancelling it.
What is intrinsic value of option?
It is the in the money portion of a call/put
What is time value of option?
The amount that an option is trading above its intrinsic value
What is open interest when describing options?
Total number of options ina series that are currently outstanding and have not been closed or exercised. traded in batches of 100
What is covered call vs naked call writing?
Covered call writer owns the underlying stock and uses this position if they are assigned.
naked call writers do not own the underlying stock and must purchase it before it can be sold to buyer (loss is technically unlimited because there is no limit to future price)
What is performance bond?
it is a good faith deposit to give other side a level of assurance that terms to a forward will be honoured
what is covered vs naked vs cash-secured put writing?
Covered: not very common as a covered put puts the seller in a short position with the stock.
naked: prepared to buy the stock but have no specifically earmarked amount of cash to buy it (loss is limited, price cant go below 0$)
cash-secured: setting aside an amount of cash equil to the strike price
Who is long and who is short in futures contract?
long position –> buyer of contract
short position –> seller of contract
Who sets the minimum and maintenance margin rates for future contracts?
The exchange where shares are traded
For futures it is generally between 3-10% (MUCH more leveraged compared to 30-80% for equities)
What is marking to market
It is the daily settlement of gains and losses on futures
When do exchange traded options typically expire?
The third friday of the expiration month, generally listed with terms of nine months or less.
Weekly options are listed for trading at open on thurdays and expire on any of the five fridays following the listing date
What is the difference btween a future and a forward?
Future is traded on exchange and is standardized
Forward: can have weird terms, less liquid (one of 2 basic derivatives)
What is a right?
privilege granted to existing shareholders that allows them to acquire additional shares from issuing company. Rights do not cost more money. E.g. give 1 right to each existing shareholder and it costs 10 rights to buy 1 share.
What is the Subscription price/offering price of a right?
The price shareholders pay to purchase additional shares of a company, almost always lower than market price
What is Record date for rights?
date at which list of shareholders who receive rights is recorded (Shares trade cum-rights before this date and ex-rights after)
What are the courses of action a rights holder can do?
- exercise some/all of the rights
- sell some or all rights
- buy additional rights to trade or exercise
- do nothing (worst option, but rights are not automatically exercised)
What is the intrinsic value of rights?
Since they are normally issued at a subscription price lower than market price, they have an intrinsic value.
Intrinsic value Ex-Rights Period = (Stock price - Exercise price)/(number of rights needed to buy share)
Intrinsic value Cum-Rights Period = (Stock price - Exercise price)/(n + 1)
How does trading rights work?
When common shares of a company are traded on the exchange, the rights are traded automatically. On TSX and TSX Venture, trading stops at noon on the expiry day.
What is regular delivery?
Rights must be settled by the second business day after transaction takes place (same as stock settlement)
What is a warrant?
Gives the holder the right to buy a share at a set price, similar to call options but issued by company itself.
Almost always issued as part of package which contains new dbet or preferred shares, help make these more attractive (Called a sweetener).
They can be sold immediately or after a certain period. Expiration can last up to several years
