Chapter 17: Futures and options Flashcards

1
Q

Derivative

A

Financial instrument whose value is dependent on the value of another underlying asset.

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2
Q

Forward contract

A

-A contract to buy (or sell) an asset on an agreed basis
in the future.
-Credit risk dependent on counter party

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3
Q

Futures contract

A

-A STANDARDISED contract, TRADED ON A
RECOGNISED EXCHANGE, to buy (or sell) an asset on
an agreed basis in the future.
-Liquid market due to high amount of identical futures

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4
Q

Functions of the exchange

A
  • Set the details of standardised contracts
  • Authorise who can trade on the exchange
  • Bring buyers and sellers together
  • Operate sub-institution called the clearing house
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5
Q

Option

A

Gives an investor the right - but not the obligation - to buy/sell a specified asset on a specified future date.

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6
Q

Call option

A

Gives an investor the right to BUY a specified asset on a specified date in the future at a specified price.

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7
Q

Put option

A

Gives an investor the right to SELL a specified asset on a specified date in the future at a specified price.

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8
Q

American option

A

Can be exercised on any date before expiry

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9
Q

European option

A

Can only be exercised at expiry

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10
Q

Warrant

A

-Option issued by a company.
-The holder has the right to purchase shares at a
specified price at specified times in the future.
-Similar to a call option.
-Bond warrants do exist as well

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11
Q

Long position in an asset

A

Means having a positive economic exposure to that asset.

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12
Q

Long party in futures contract

A

The party who has contracted to take delivery of the asset in the future.

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13
Q

Short position in an asset

A

Having a negative economic exposure to that asset.

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14
Q

Short party in futures contract

A

One who has contracted to deliver asset in the future.

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15
Q

Clearing house

A

-Self-contained institution whose only function is to
clear FUTURES trades and settle margin payments.
-The clearing house checks that the buy and sell orders
match
-Acts as a party to every trade.
-Guarantees each side of original bargain, removes
credit risk. Uses initial and variation margins.

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16
Q

Clearing house as a party to every trade

A

It simultaneously acts as if it had sold to the buyer and bought from the seller.
Following registration, each party has a contractual obligation to the clearing house.
In return, the clearing house guarantees each side of the original bargain, removing the credit risk to each of the individual parties.

17
Q

Credit risk

A

Risk of one of the parties to the trade defaulting on the agreement.

18
Q

Exercise price

A

price at which an underlying security can be sold to (for a put) or purchase from (for a call) the writer or issuer of an option (or option feature on a security).

19
Q

Option premium

A

Price that the option holder pays the option writer for the right to exercise (or not exercise) the option.

20
Q

Closing out position

A

Taking out an equal, but opposite contract. Applies to futures.

21
Q

Uses of equity warrants

A

-No rights that come with holding equity warrant, but protected from changes in OS capital. i.e rights issues
-Number of shares and exercise price can be adjusted
later on if such an event occurs.
-Added on to other benefits to attract different
investment market and reduce GRY on bonds since
higher yields aren’t needed to attract investors

22
Q

Futures vs Options

A
Futures: 
Obligation 
Exchange-traded
Standardised
No premiums paid (margins are deposits)
Margins paid by both parties
Options: 
Right
OTC & Exchange
Non & Standardised
Premiums paid
Margin only paid by writer since only obligated trader