Chapter 10 - Derivatives

Question 1

Futures

Answer 1

Definition: agreement to buy/sell a specified quantity at a specified price in the future

Fair value=Spot price (today’s value) + Costs of carry (how much to hold until set date e.g storage, insurance charges)

Basis = Cash/spot price - Futures price

Contango - asset prices rise and future price ends up being high than spot (negative basis)
Backwardation -asset prices rise and future price ends up being high than spot (positive basis)

Index arbitrage

Question 2

Option

Answer 2

Definition: gives buyer the right to buy/sell a specified quantity at a specified price in the future

European - rights can only be exercised on expiry date
American - can be excersied on any date