Chapter 10

Question 1

What is a derivative?

Answer 1

Contract between two parties where one of the individuals can buy or sell the underlying asset at an agreed-upon price.

Question 2

What qualify as derivatives?

Answer 2

Stock, bond, a commodity, different currencies etc.

Question 3

The price the investor gets to buy or sell the underlying asset is referred to as…?

Answer 3

Exercise price, subscription price, or strike price.

Question 4

What is a warrant?

Answer 4

Warrants are a derivative that give the right, but not the obligation, to buy or sell a security—most commonly an equity—at a certain price before expiration.

Question 5

Remember that when an investor gets to buy or sell an underlying asset it is…?

Answer 5

The exercise, subscription or strike price! :)

Question 6

What is strike price?

Answer 6

A strike price is the set price at which a derivative contract can be bought or sold when it is exercised?

The strike price will be above the current value of the stock/bond

Think of your stocks, the strike price is what you either sell MRNA, SHLL, NVAX at or what you buy it at.

Question 7

Call option?

Answer 7

For call options, the strike price is where the security can be bought by the option holder.

Remember that call means BUY
You call to order food aka BUY food like pizza! :)

Question 8

Put option.

Answer 8

For put options, the strike price is the price at which the security can be sold.

PUT=SELL

Think if you are putting something online to sell like a bike or a house your put it up to SELL!!

Question 9

Good to know…

Answer 9

The strike price, also known as the exercise price, is the most important determinant of option value.

Question 10

Exercise if…

Aka

SELL or BUY if…

Answer 10

Face Market Value (FMV) is > (greater than) strike price

Let me explain..

FMV is the cost of a share at any given term or derivative

The strike price is the desired cost, so what you want to buy or sell at.

If the market value is greater that the strike price you would want to buy or sell that stock.

If you want to buy wait until its low if you want to sell wait until its high.

Question 11

DO NOT exercise…

AKA buy or sell if…

Answer 11

Face Market Value (FMV) < strike price

Because you’re paying more than its worth.
Always think of your own assets aka stocks, bonds, mutual funds etc…

Question 12

What is Intrinsic Value?

Answer 12

The deal you are getting when you buy or sell the asset

The intrinsic value is a way an investor can model to predict what they will make if the sell or buy at a good price.

It’s a prediction of what the asset will be worth. Remember strike price is like the desired price you want to buy or sell at.

FMV (face market value)-strike price

Question 13

What is Market Value?

Answer 13

Market Value (FMV)

=Time value +intrinsic value

Question 14

What are rights?

Answer 14

• Issued by a company to raise capital
• Issued by existing shareholders based on number of shares they have
• Have an exercise price below the current market price of stock
• Have a life span that is SHORT TERM (4-6 weeks) you want to raise capital NOW not later

If rights are valuable either 1) exercise or 2) sell to another investor.

• Rights fully subscribed=fully exercised
• Rights not fully subscribed= not everyone exercised their rights

Question 15

More on RIGHTS.

Answer 15

A rights issue is one way for a cash-strapped company to raise capital often to pay down debt.

-Think of like a start up company like a pharmaceutical company that needs funding to get through the next phase of clinical trial or a company that needs money in order to see their idea through.

Shareholders can buy new shares at a discount for a certain period.

With a rights issue, because more shares are issued to the market, the stock price is DILUTED and will likely go down.

• DILUTED more shares means stock will go down
• If more people own stock its not “exclusive” and worth as much

Question 16

What are Options?

Answer 16

• Options contract is like a bet
• Think of a bet one person wins one loses
• Only the investor who is right will make profit

Question 17

Call Options.
AKA BUY

Strike price (desired price) is less than < Face Market Value

Answer 17

BULLISH MARKET =BUY

Means there is a strong market prices will rise.

This is also a CALL HOLDER.

• option to buy underlying shares at the exercise price
• pays the premium

CALL WRITER

• obligated to sell
• BEARISH MARKET =SELL

Question 18

Put Options…

PUT=SELL

Strike price (desired price)> greater than Market Value

Answer 18

Put holder aka buyer of the option.

Put writer aka seller of the option.

In finance, a put or put option is a stock market instrument which gives the PUT holder (i.e. the purchaser of the put option) the right to SELL an asset (the underlying), at a specified price (the strike), by (or at) a specified date (the expiry or maturity) to the writer (i.e. seller) of the put.

Question 19

Covered call writer?

Answer 19

Sell call shared that you actually own.

Question 20

Naked call writer?

Answer 20

Sell call shares that you do not own.

Question 21

In the money

Is a GOOD THING !! :)

Answer 21

Call = Market Value is greater than > strike (that set or desired price)

-this means that the strike price is lower than the current stock price

You exceeded it so you are in the money !!

Put= Market value

Question 22

Out of the money

Bad thing!

Answer 22

CALL AKA BUY-FMV< STRIKE PRICE

PUT AKA SELL-FMV>STRIKE

Question 23

Forwards

Answer 23

Forwards: trade OTC

Remember O in forward means OTC

Question 24

Futures

Answer 24

Futures trade on exchange
-based on interest rates and currencies

Makes sense because interest rates and currencies change in the future and with certain circumstances

Question 25

Marking the Market

Answer 25

-the loser of the bet, paying daily the losses so the hit isn’t so hard (example is mortgage payments, easier to pay off over the years than upon maturity)

Good faith:
Offer something of insurance like a down payment for a house that the bet or debt will be paid off at some point.

Question 26

Long a futures contract.

Answer 26

Long means BUY

When you are longing for a water ski lake and new boat you want to buy it so badly.

-Obligated to buy the commodity

-A commodity is a basic good used in commerce that is interchangeable with other commodities of the same type.
Commodities are most often used as inputs in the production of other goods or services.

Question 27

Short a futures contract.

Answer 27

You are the person who is obligated to SELL the commodity.

Question 28

Study differences between exchange traded and over the counter!

Answer 28

OTC IS FORWARD
-private
-not heavily regulated 
EXCHANGE IS FUTURE 
-public 
-heavily regulated 

*chart in notes

Question 29

Why do we use derivatives?

Answer 29

• Hedging – protecting against the downside, and entering a future contract where the other party is obligated to purchase the good at a higher than market value
• Speculating – anticipating price or commodity to increase in value
o Used when there is no need
• Easy market entry and exit – if you anticipate a change in the market, you can buy a derivative with the index fund as an underlying asset and buy and sell it accordingly in a day (vs. buying all the funds that make up the indices)
• Enhance yield – will benefit from the appreciation of a stock, but can also make money if the stock performs poorly as well
• Arbitrage – where one share is sold at different prices on different exchanges, and you buy at the lower one and sell at the higher one

Question 30

What is hedging?

Answer 30

A hedge is an investment that protects your finances from a risky situation. Hedging is done to minimize or offset the chance that your assets will lose value. It also limits your loss to a known amount if the asset does lose value.