Chapter 3 - Alternative Investments and Derivatives Flashcards
What are derivatives?
A derivative is a financial instrument that is based on some other asset.
The key difference in buying a derivative rather than the asset itself is that the cost of buying the derivative is a fraction of the cost of buying the asset.
What are the main types of derivatives?
A future
Exchange-traded contract to buy or sell an asset at a future date for a certain price
An option
Gives the holder the right, but not the obligation to buy or sell an asset at a future date.
A swap
An agreement between two parties to exchange a series of cash flows over a period of time, most common is interest rate swap.
What are the four reasons why an investment manager might choose future contracts?
1 - May require equities to be held.
2 - Selling a large portfolio could result in significant dealing costs.
3 - Future markets being more liquid than security markets.
4 - Future incur lower dealing costs.
What is a Call Option?
The buyer has the right to buy the asset at the exercised price they choose. The seller is obliged to deliver if the buyer exercises the option.
What is a Put Option?
The buyer has the right to sell the underlying asset at the exercised price.
What is a traditional Warrent?
Issued by companies such as investment trusts and traded on the london stock exchange. Long term call option.
What are contracts for differences (CFD)
Used to trade shares - short or long
They are a geared investment so only a proportion of the value of a trade is needed to fund a trade.
What are Hedge Funds?
Hedge funds are investment funds that pool investors money to invest,
Advantages of Hedge Funds
Diversification
Can access markets and trading methods not available in traditional investment vehicles.
Volatility
Offers strategies aiming for low volatility and very popular with wealthy clients
Expertise
Hedge fund managers are experts in a highly specialised area.
Disadvantages of Hedge funds
Lack of regulation and protection
They are lightly regulated and have no protection in place
High minimum investments
Minimum investment of £1,000,000 is very common.
Complexity
Very difficult to monitor or objectively assess with the complexity of this area
Volatility
Offer outstanding returns and spectacular failures,
What is a Structured Deposit?
Designed to return investor’s original capital as minimum
Authorised by PRA also includes FSCS protection.
What is a Capital-protected product?
Designed to return at least the original capital, no matter how bad the market is performing.
No FSCS protection.
What is Capital-at-risk Products?
Potential to product higher returns but can rise to a loss at maturity if the performance has been poor.
They have a barrier to protect capital, typically 35%.
What is a zero-coupon bond?
Fixed-interest security that pays no coupon but is instead sold at a discount to its par value so can provide a known amount at its maturity.
What is a structured product (Income Plan)?
Designed to provide a stream of income payments paying monthly, quarterly half-yearly or annually.
