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FCA Derivatives > Chapter 2: Underlying Markets > Flashcards

Chapter 2: Underlying Markets Flashcards

1
Q

Why do interbank Money Markets (MMs) exist?

A

To facilitate short term borrowing in order to meet short term borrowing requirements by banks. Facilitates liquidity in the market.

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2
Q

What are the 3 main published interest rats available to banks across the UK, EU and US?

A

SONIA - Sterling Over-Night Index Average
SOFR - Securities Over-Night Finance Rate
ESTR - Euro Short-Term Rate

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3
Q

What are the characteristics of the SONIA? Who calculates the SONIA?

A

UK bank rate (replaced LIBOR)
Bank of England calculates
Calculated using short term sterling rates from previous day by 7am
Published at 9am GMT

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4
Q

What are the characteristics of the SOFR?

A

US benchmark for derivatives and loans.
Measures cost of borrowing overnight vs single day repo rate
Volume weighted on market data from General Collateral (GC repo)

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5
Q

What are the characteristics of the ESTR?

A

Wholesale overnight euro rate and published on each TARGET2 business day
Calculated on all borrowing transactions over 1 million

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6
Q

What are the key features of UK T-Bills?

A

Issued by the Debt Management Office (DMO)
Issued weekly
Typical maturity of 91 days, although 182 bill are also issues

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7
Q

What is the coupon paid on T-Bills?

A

There is no coupon paid on T-Bills. These are ZCBs.

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8
Q

What are the key features of US T-Bills?

A

Issued by the Treasury
Issues weekly
Typical maturity of 28 days, 3 months and 6 months

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9
Q

What is a Certificate of Deposit (CD)?

A

Savings account where banks can use the funds, paying fixed interest.
Typical maturity of 3 and 6 months.
Issued in any denomination.

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10
Q

What is Commercial Paper (CP)?

A

Typical maturity ranging between 2 and 9 months.
Denominated in minimum $500,000

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11
Q

What are the 3 FX major trading sessions?

A

Tokyo
London
New York

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12
Q

Why is the FX market unique?

A

Large trading volume
Decentralised trading
Geographical dispersion
24hr trading
Variety of factors affecting exchange rates

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13
Q

In FX transactions, what order do the base and exchange currencies come in as well as the bid and offer?

A

Base currency first, exchange currency second.
Bid first (price offered to buy base currency)
Offer second (price offered to sell base currency)

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14
Q

What are forward points in the FX market and what does it indicate if they increase or decrease?

A

Forward points indicate how the forward rate changes in relation to the spot rate.
When forward points decrease, the bid decrease is greater, meaning the spot rate is advantageous when buying base. This therfeore means forwward rate is trading at a discount.
This is flipped when forward points increase.

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15
Q

What are NDFs? What are the fixing and settlement dates? What time periods are NDFs quoted for?

A

An NDF is a cash settled short-term FX forward on thinly trades currency. Fixing date is when the market exchange rate and the agreed exchange rate are calculated.
Settlement date is the date the difference is netted and paid to the profiting party.
Commonly quoted between 1 and 12 months.

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16
Q

What is the Interest Rate Parity formula used when calculating the correct FX forward rates?

A

Forward rate = spot rate x ((1+(nxr1))/(1=(nxr2))
R1 = interest rate in exchange currency
R2 = interest rate in base currency
N = period

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17
Q

In FX markets, what is a pip?

A

Similar to full tick value in futures markets, a pip is the minimum change an exchange rate can make.

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18
Q

What are the characteristics of UK gilts?

A

Coupon - semi annual
Maturity - up to 50 years
Settlement - T+1

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19
Q

What classifies short, medium and long maturity on bonds?

A

Short - less than 7 years remaining
Medium - 7-15 years remaining
Long - more than 15 years remaining

20
Q

What are index-linked and floating rate bonds?

A

Index-linked bonds protect against inflation whereby both the maturity payment and coupon payments are linked to a published measure of inflation.

21
Q

What is the current index lag on UKindex-linked bonds and when did this change?

A

The index lag on current UK bonds is 3 months, however bonds issues before 2005 have an 8 month index lag.

22
Q

What are sovereign eurobonds?

A

These are bonds issued by the domestic government denoted in another currency at significantly lower rates.

23
Q

What is yield spread in the bond market?

A

A simple calculation to work out the differences between 2 bonds with similar maturity dates by subtracting one yield by another and taking the absolute value.

24
Q

What does yield spread increasing imply?

A

The issuing entity of one bonds credit rating may have remained the same, whilst the other’s has dramatically decreased or increased.

25
Q

What are STRIPS?

A

Separated Trading of Registered Interest and Registered Principal of Securities. When a bound is issued, some bonds are eligible to split into their individual cashflows and marketed as individual securities.

26
Q

What is a Zero Coupon Bond (ZCB)

A

A bond that issues at a discount to their nominal value at redemption and pay no coupon.

27
Q

What does the normal, flat and inverse yield curves imply?

A

Normal - investors have a liquidity preference
Inverted - occurs when interest rates are expected to rise
Flat - market is slow to reflect higher term rates increase after short term rates have increased

28
Q

What are corporate bonds? What are listed corporate bonds?

A

Corporate bonds are issued by large corporations and have a maturity of at least 12 months. Listed corporate bonds are either listed on an exchange or Electronic Communication Networks (ECNs).

29
Q

What are the differences between preference and ordinary shares?

A

Preference shares:
Pay a fixed dividend
Non-voting
Rank ahead of ordinary shares in capital repayment

30
Q

What are the types of preference shares?

A

Cumulative - if dividends are missed, they accumulate until fully paid.
Participating - has voters rights
Redeemable - companies can redeem early and pay shareholders at a pre-agreed price.
Convertible - shareholders can convert to ordinary shares at pre-determined date and price

31
Q

What are the differences between an equity option and an equity warrant?

A

An equity option is traded on an exchange, whilst equity warrants are sol by the issuer privately. Equity options are not usually listed by the issuer unless in an IPO.

32
Q

What is the difference between an equity warrant and a convertible bond?

A

Convertible bonds are converted into equity when redeemed, whilst the bond is ceased. Equity warrants can be exercised whilst the bond continues to pay coupons and the maturity payment.

33
Q

Do warrants have an expiry date and in what style are they redeemed?

A

Warrants expiry date is determined before hand and so is their exercise style. See options exercise style for more detail.

34
Q

What is the warrants conversion ratio?

A

The number of warrants needed to buy one share. A 3:1 conversion ration would mean 3 warrants are required.

35
Q

What is Gordon’s Growth Model (GGM)?

A

Determines a shares value based on its forecasted dividends assuming they grow at a constant rate.

Share price= value of next years dividend / (constant cost of equity - constant growth rate

36
Q

What is Earnings Per Share (EPS)?

A

Displays a companies overall earnings across all ordinary shares. EPS = Net income - dividends on preference shares / number of ordinary shares

37
Q

What is the Earnings Yield (%)

A

Earnings Yield = EPS/ Market price

38
Q

What is the P/E ratio?

A

P/E ratio = Market Price / EPS

39
Q

Why is the P/E ratio useful?

A

Can show performance well
Can be useful wen comparing different companies to invest into
Risk - can show perception of a company’s risk - high P/E would show low risk

40
Q

How do you calculate NAV and NAV per share?

A

NAV = assets -liabilities
NAV p/s = assets - liabilities / no. ordinary shares

41
Q

What is a bonus issue?

A

Obligatory corporate action where holders of shares will be given shares in proportion to their existing holding.

42
Q

What is a rights issue?

A

Holders of shares will be given an opportunity to buy additional shares at an advantageous price

43
Q

What is a stock split?

A

The same as a bonus issue, however reflects differently on the balance sheet.

44
Q

What are the 3 types of commodities?

A

Agriculturals and softs
Energy
Minerasl

45
Q

Areas to add - credit ratings, bond specifications and types of commodity derivatives markets

A
46
Q

What are the 3 primary factors of crude oil?

A

Field of origin
Sulphur content
Density

FCA Derivatives (9 decks)

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