Chapter 10

Question 1

what is a derivative?

Answer 1

A contract between two parties to whose value is based on an underlying asset. such as a stock, bond, currency or interest rate, a futures contract or an equity index

Question 2

what are the two types of derivatives?

Answer 2

1. Options
   is a contract between buy and seller they have right to buy shares at a specific time but are not required to. the seller is required to.
2. Forward
   same but both parties are obligated to transaction on specified date.

Question 3

what are common features of a derivative?

Answer 3

There are two counter parties a buyer and a seller. the agreement spells out the rights and obligations of both parties. all derivatives have an expiration date.

Question 4

what are the differences between forwards and options?

Answer 4

Forwards there is not upfront cost. Both parties are obligated to execute trade at expiration date. although buyer can give a performance bond or good faith deposit upfront

Options there is a upfront payment “premium” the buy has the option to exercise trade on expiration date

Question 5

Explain OTC derivatives

Answer 5

Traded anytime, there is no trading floor. Special features can be added to contracts easily.

OTCs are less liquid because transactions are private

Question 6

Explain Exchange traded derivatives

Answer 6

A derivative exchange is a legal corporate entity organized for trading derivatives

can easily make offsetting position to cancel current position.

Montreal exchange
ICE futures exchange (trades barley and canola)

Question 7

who clears trades on the montreal and ice futures exchange?

Answer 7

The canadian derivatives clearing corporation

Question 8

what are the two main categories of underlying derivatives?

Answer 8

Commodities and financial assets

Question 9

who are the 4 groups that use derivatives?

Answer 9

1. individual investors
2. businesses
3. corporation
4. Derivative dealers

Question 10

What is hedging?

Answer 10

If an investor owns an asset and is worried it is going to go down in value in the future. They can hedge against that asset mitigating the losses.

Question 11

what is arbitrage?

Answer 11

When a investor sees that the price of an asset or commodity are trading a two different prices on two markets.
The investor buys on the cheaper market and sells it on the more expensive market almost simultaneously

Question 12

what is yield enhancement?

Answer 12

taking a speculative position betting on future price movements

Question 13

on the canadian otc markets who are the derivative dealers?

Answer 13

the big six banks