Chapter 10 Flashcards
___: trade today
___: trade tomorrow
___: might trade tomorrow
spot; forward/future; option
intertemporal securities which ‘derive’ their value from the underlying asset
derivatives
An agreement between two parties to exchange a standard quantity of an asset at a predetermined price at a specified date in the future.
derivative security
agreement made between a buyer and a seller at time 0 for the seller to deliver the asset immediately and the buyer to pay for the asset immediately
spot contract
agreement between a buyer and a seller at time 0 to exchange a non-standardized asset for cash at some future date. the details of the asset and the price to be paid at the forward contract expiration date are set at time 0.
- the price is fixed over the life of the contract
forward contract
agreement between a buyer and a seller at time 0 to exchange a standardized asset for cash at some future date. Each contract has a standardized expiration and transactions occur in a centralized market
- the price changes daily as the market value of the asset underlying the futures fluctuates
futures contract
Describes the prices on outstanding futures contracts that are adjusted each day to reflect current futures market conditions.
marked to market
US treasury futures settlement procedures
settlement
A purchase of a futures contract.
long position
A sale of a futures contract.
short position
The unit that oversees trading on the exchange and guarantees all trades made by the exchange traders.
clearinghouse
___ requirements on futures that act as a security bond should a counterparty default
margin
A deposit required on futures trades to ensure that the terms of any futures contract will be met
initial margin
The margin a futures trader must maintain once a futures position is taken. If losses on the customer’s futures position occur and the level of the funds in the margin account drop below the maintenance margin, the customer is required to deposit additional funds into their margin account, bringing the balance back up to the initial margin.
maintenance margin
An investment in which traders post and maintain only a small portion of the value of their futures position in their accounts. The vast majority of the investment is borrowed from the investor’s broker.
leveraged investment
if losses on the customer’s futures position occur and the level of the funds in the margin account drops below a stated level, the customer receives a ___ ___
margin call
a long position in the futures market produces a profit when the value of the underlying T-bond ___
increases
a short position in the futures will produce a profit when the value of the underlying t-bond ___
decreases (i.e. interest rates rise)
the amount of the margin varies according to the type of contract traded and the ___ of futures contracts traded (e.g. 5% margin of the value of the underlying asset)
quantity
A contract that gives the holder the right, but not the obligation, to buy or sell the underlying asset at a specified price within a specified period of time.
option
An option that gives a purchaser the right, but not the obligation, to buy the underlying security from the writer of the option at a prespecified exercise price on or before a prespecified date.
call option
- owner is long the underlying, writer is short
if, as the option expires, the price of the stock underlying the option, the buyer makes a profit
–> which is the difference between the __ __ and the ___ ___ of the option ___ the ___ ___ ___ to the writer of the option
stock’s price; exercise price; minus; call premium paid
the higher the underlying sock’s price at expiration, the ___ the profit on the exercise of the option
larger
(as the underlying stock’s price rises, the call option buyer has a large profit potential)
buying a call option is an appropriate position when the underlying asset’s price is expected to ___
rise
if the underlying sock’s price at expiration is ___ the exercise price, the call buyer is not obligated to exercise the option
the buyers losses are limited to the amount of the __ __ payment made to purchase the call option
below; up-front premium
in writing a call option on a stock, the writer or seller receives an up-front fee or premium and must stand ready to ___ the underlying stock to the purchaser of the option at the exercise price
sell
as the underlying stock’s price falls, the potential for a call option writer to receive a positive payoff (or profit) ___
increases
as the underlying stock’s price ___, the call option writer has unlimited loss potential
rises
if the underlying stock’s price is ___ than the exercise price at expiration, the call option buyer will exercise the option, forcing the option writer to __ the underlying stock at its high market price and then ___ it to the call option buyer at the lower exercise price
greater; buy; sell
An option that gives a purchaser the right, but not the obligation, to sell the underlying security to the writer of the option at a prespecified price on or before a prespecified date.
put option
- owner is short the underlying, writer is long
The difference between an option’s exercise price and the underlying asset’s price.
- payoff if the option was exercised right now
intrinsic value of an option
The difference between an option’s price (or premium) and its intrinsic value.
- value in excess of intrinsic, from time to expiration
time value of an option
An option that can be exercised at any time before and on the expiration date.
American option
An option that can be exercised only on the expiration date.
European option
the underlying asset on a ______ is the value of a major stock market index (e.g. the DJIA or the S&P 500 index)
stock index option
the difference between a stock option and a stock index option is that at expiration, the stock index option holder ___ settle the option contract with the actual purchase or sale of the underlying stock index, instead they are settled in ___
cannot; cash
the underlying asset on a ___ ___ contract is the stock of a publicly traded company
stock option
one option generally involved ___ shares of the underlying company’s stock
100
regulates all securities traded on national securities exchanges, including several exchange-traded derivates
SEC
has exclusive jurisdiction over all exchange-traded derivative securities and regulates all national futures exchanges, as well as all future and options contracts
Commodities Futures Trading Commission (CFTC)
An agreement between two parties to exchange a series of cash flows for a specific period of time at a specified interval.
swap
An exchange of fixed-interest payments for floating-interest payments by two counterparties.
interest rate swap
By convention, a party that makes the fixed-rate payments in an interest rate swap transaction.
swap buyer
By convention, a party that makes the floating-rate payments in an interest rate swap transaction.
swap seller
A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities.
currency swap
fastest-growing types of swaps have been those developed to better allow financial institutions to hedge their credit risk
credit default swap
the ___ ___ __ was an important factor leading to the global financial crisis of 2008, which witnessed the after-effects of poor loan underwritting, shoddy documentation and due diligence, failure to monitor borrower activity, and fraudulent activity on the part of both lenders and borrowers
loosening of incentives
A call option on interest rates, often with multiple exercise dates.
cap
buying a cap means buying a call option or a succession of call options on ___ ___
interest rates
A put option on interest rates, often with multiple exercise dates.
floor
buying a floor is similar to buying a ___ ___ on interest rates
put option
A position taken simultaneously in a cap and a floor.
collar
(the idea is that the firm wants to hedge itself against rising rates but wants to finance the cost of the cap)
you can ‘offset’ a futures contract by entering into an ___ ___
opposite contract
(both contracts expire at the same time, the gold purchased from the ‘long’ contract is sold to the ‘short’ contract)
- owner/buyer of the contract chooses if future trade happens
- writer/seller of the contract has no choice
- everything else is fixed
- owner buys the option from the writer, paying them a premium
option to trade
option to trade (call vs. put):
- transaction price:
- expiration date:
- quantity:
- transaction price: strike/exercise price
- expiration date: 3rd friday of the month
- quantity: 100 shares
