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CISI: Derivatives > Chapter 2: Underlying Markets > Flashcards

Chapter 2: Underlying Markets Flashcards

1
Q

Why do money markets exist?

A

Banks will have a surplus or deficit of cash

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2
Q

What is the SONIA and what is it used for?

A

Sterling Overnight Index Average
Rate for unsecured transactions in London sterling market

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3
Q

How does the BoE calculate SONIA?

A

Financial institutions will send details of their transactions of short term rates
BoE validates this data

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4
Q

What is €STR and what is it used for?

A

Euro Short-Term Rate
European SONIA, based on TARGET2 transactions

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5
Q

What is TARGET2?

A

Trans-European Automated Real-Time Gross Settlement Express Transfer System
Settlement/Payments system

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6
Q

What is the SOFR and what is it used for?

A

Secured Overnight Financing Rate
Benchmark interest rate for dollar-denominated derivatives and loans
Based on repo rate for USTs, since 2018

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7
Q

What are T-bills?

A

Treasury bills
Short term debt issued by governments

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8
Q

Why are T-bills sometimes called promissory notes?

A

Backed by the promise of a government

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9
Q

What is a certificate of deposit?

A

Promissory note from financial institution if investors put their money away for set amount of time

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10
Q

What minimums do CP usually have?

A

$500k

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11
Q

What is spot FX settlement time?

A

T+2

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12
Q

What is used to calculate forward rates?

A

Spot rate and interest rate differentials

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13
Q

What is a non deliverable forwards?

A

Cash settled, short term FX contract on a thinly traded or non-convertible international currency

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14
Q

How is profit or loss calculated on an Non-Deliverable forwards?

A

Difference between agreed exchange rate and spot rate at the time of settlement

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15
Q

What do all NDFs have?

A

fixing date - date which the difference between market and agreed rate is calculated
settlement date - date by which the payment of the difference is due

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16
Q

What is a common time period for NDFs?

A

one month - a year

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17
Q

What are NDFs usually traded against?

A

Illiquid currencies or those with currency controls e.g. CNY
Settled in USD, or EUR/GBP

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18
Q

What is interest rate parity?

A

The theory that forward rates are in line with relative interest rates, else arbitrage would be possible

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19
Q

How can the link between relative interest rates and FX be summarised?

A

Higher interest rate currency = Discount in the forward foreign exchange market
Lower interest rate currency = Premium in the forward foreign exchange market

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20
Q

What needs to be taken into account when calculating FX rates of less than one year?

A

Day count conventions

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21
Q

What is the formula for forward rate?

A

Spot rate *
(period * interest rate traded currency + 1) / (period * interest rate base currency + 1)

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22
Q

How would you calculate the premium or discount?

A

forward rate - spot rate

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23
Q

What is the settlement period of French, German and Italian bonds?

A

T+2

24
Q

Which bonds have annual coupon frequencies?

A

French and German

25
Q

What is the difference between floating rate and index linked bonds?

A

Index linked - RPI/CPI etc
Floating rate - SONIA / SOFR

26
Q

What is indexation lag?

A

Protects against inflation for the last interest period of a bonds life

27
Q

Why may an emerging market country issue bonds in EUR or USD?

A

Lower interest rates than home currency

28
Q

What are bonds issued by governments in other than their home currency called?

A

Sovereign eurobonds

29
Q

What is the yield spread?

A

Difference between the quoted rates of return of two different bonds that have similar maturities

30
Q

What does the yield curve show?

A

The yields available to investors over different maturities of the same bond

31
Q

Why is the yield curve curved? (2)

A

Liquidity preference
Shorter-dated bonds have higher liquidity
Investors prefer higher liquidity so are willing to accept a lower yield

Risk
Other risks increase over time such as inflation or default

32
Q

When does an inverted yield curve arise?

A

Yields on short dated > yields on higher dated bonds
Occurs when there is an expectation of a reduction in interest rates at some stage in the future

33
Q

Where can bonds be listed (3)

A

Exchanges
ECNs (electronic communication networks)
Decentralised dealer based OTC markets

34
Q

Where is most volume traded for bonds?

A

Decentralised dealer based OTC markets

35
Q

How are dividends paid on bearer shares?

A

Holder clips a coupon from certificate and submits it to the paying agent

36
Q

What is a partly paid share?

A

One where only a portion of the purchase price has been paid to the issuing company
Firms directors can call up capital from investors

37
Q

What do preference shareholders receive preference on?

A

Dividends and capital repayment

38
Q

What is a participating preference share?

A

Allows shareholder to receive any excess dividend if company makes more money

39
Q

What is a convertible preference share?

A

Preferential rights with the option to convert their holding into ordinary shares at a future date/price

40
Q

Why may a warrant conversion ratio be adjusted?

A

To account for any corporate actions that change share structure

41
Q

How does Gordons growth model calculate share value?

A

Forecasting future dividend payments, assuming a constant growth rate

42
Q

What is the Gordons growth model?

A

A valuation technique

43
Q

What is the Gordons growth model formula?

A

price = next year dividend / (cost of equity capital - constant growth rate)

44
Q

What is the formula for EPS?

A

net income - dividends on preferreds / number of ordinary shares

45
Q

What is the calculation for NAV?

A

assets - liabilities

46
Q

What is the earnings yield calculation?

A

Earnings yield (%) = EPS / market price

47
Q

Where does NAV not work?

A

Companies where value is made from people skills e.g.
Law firms, architecture firms

48
Q

What are the three main categories of commodity?

A

Agricultural and softs - sources of calories and cash crops (softs) e.g. coffee, sugar
Energy
Minerals - inc. precious metals

49
Q

What is carry cost called for commodities and what can it include?

A

Holding cost
Warehousing, spoilage, interest, taxes

50
Q

What 3 factors is crude oil defined by?

A
  • Field of origin – for example, Brent, West Texas, Dubai, or Oman.
  • Density – ie, low density or ‘light’, high density or ‘heavy’.
  • Sulphur content – ie, low sulphur or ‘sweet’ (ie, sulphur content below 0.5%), high sulphur or ‘sour’
    (ie, sulphur content above 0.5%).
51
Q

What is the difference between WTI and Brent?

A

WTI is a stored oil contract, where someone must nominate a US storage facility
Brent you nominate a port for delivery

52
Q

What is the difference between coins and tokens in crypto?

A

Coins have their own blockchain
Tokens reside on existing blockchain

53
Q

How are weather derivatives measured?

A

Using HDDs or CDDs
heating degree days or cooling degree days

54
Q

What is the VIX based on?

A

IV of the SP500

55
Q

What emission contracts can be traded?

A

Carbon dioxide, sulphur dioxide, methane, nitrogen dioxide

56
Q

What are freight derivatives?

A

Financial contracts based on the future levels of freight rates
Mostly OTC

CISI: Derivatives (10 decks)

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