Chapter 5: Principles of OTC Derivatives Flashcards

1
Q

What is a pip?

A

Smallest price increase in a currency, similar to a tick

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is the minimum period for a forward in FX?

A

Anything above T+2

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What will happen to quoted spreads as a forwards contract that is further out?

A

They will widen, as this carries more risk for the dealer

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What is the relationship between premium and change to spot?

A

Inversely
+ premium = -spot

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

How is the premium calculated?

A

Using the relevant STIRs of the two currencies

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is a cap?

A

Option product, protect the cost of a floating-rate borrowing cost

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What is a floor?

A

Option that allows a buyer to demand a minimum rate of interest paid on a deposit

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What is a collar?

A

Mix of a floor and a cap, allows a buyer to ensure interest is always received within a range

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is a credit derivative?

A

Derives its value from credit events relating to a third-party company
E.g. credit rating downgrade

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is a credit default swap?

A

Party pays periodic payments to another party
Receives agreed compensation if there is a credit event

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What is considered a credit event? (6)

A

Default
Fall in price/value
Bankruptcy
Debt restructure
Merger/demerger
Gov actions

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What are the three types of CDS?

A

Single-name or basic
Basket
Index

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is a basket CDS?

A

CDS based of a basket of securities, such as several airline debts
can be a range of criteria to receive payment

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

What is the most widely used probability of default?

A

Premium of an asset over a reference rate

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is a credit linked note (CLNs)?

A

Form of funded credit derivative
Allows issuer to transfer a credit risk to credit investors

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What is a credit spread option?

A

Strike rate set on a spread between yield on a particular asset and agreed benchmark
Pay-off based on whether the market spread at exercise date is different

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

What is a credit spread?

A

Difference between the yield on an asset vs an agreed benchmark (e.g. USTs)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

Which types of options can credit spreads options be?

A

American or European

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

What is a credit default option?

A

Option to buy protection or sell protection on a CDS.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

What style of option are credit default options?

A

European

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

What is a collateralised debt obligation (CDO)?

A

Structured ABS
Value derived from a portfolio of fixed-income securities
Split into different tranches

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

How is a CDO created?

A

A corporate entity is constructed to hold assets as collateral and sell cash flows to investors

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

What does issuing CDOs allow originators to do?

A

Pass on the credit risk of the underlying assets
e.g. bank issues mortgages but passes on risk to investors

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

What is a collateralised bond obligation (CBO)?

A

Creates an investment grade bond from a pool of junk bonds, diversification decreases risk

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

What is a cliquet or ratchet option?

A

Series of ATM options with periodic settlement
Strike price resets to price level at that time
Locks in the difference between old and new strike

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

What is a knock-in option?

A

Only come into existence when underlying crosses a barrier price

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

What is a knock-out option?

A

Exist when agreed, no longer exists when underlying crosses a barrier price

28
Q

What are the different types of barrier option? (4)

A

Down and in, is a knock-in type of option that is activated when the asset’s price falls to, or below, the pre-determined level.
* Down and out, is a knock-out type of option that is cancelled when the asset’s price falls to, or below, the pre-determined level.
* Up and in, is a knock-in type of option that is activated when the asset’s price rises to, or above, the pre-determined level.
* Up and out, is a knock-out type of option that is cancelled when the asset’s price rises to, or above, the pre-determined level.

29
Q

What is delta?

A

The ratio comparing the change in the price of asset to option value

30
Q

What is the range of Delta?

A

0-1

31
Q

What would an option that is ITM have a delta of?

A

1

32
Q

How does delta differ between calls and puts?

A

Calls: +
Puts: -

33
Q

What is Gamma?

A

Rate of change for delta with respect to asset price
First derivative of delta

34
Q

What is Gamma used to measure?

A

How deep ITM or OTM an option is
Gamma smaller for near-the-money
Gamma larger for deep ITM/OTM

35
Q

What is Vega

A

Change in options value for a 1% change in implied volatility

36
Q

What does vega differ between calls and puts?

A

It doesn’t - it is absolute

37
Q

When is Vega greatest?

A

ATM and longer options

38
Q

What is Theta?

A

The rate of decline in the value of an option due to the passage of time, AKA time decay

39
Q

What is Rho?

A

Estimate of the sensitivity of an option to changes in interest rates

40
Q

What is a major drawback to the Black-Scholes model?

A

Assumes that volatility is a constant

41
Q

What is the Stochastic Alpha, Beta, Rho (SABR) model?

A

Volatility model that says asset price and volatility are correlated
Used in interest rate derivative markets

42
Q

What are volatility smiles?

A

Implied volatility patters that arise in pricing options

43
Q

What is the market standard for OTC options premium settlement?

A

Next day or T+2 at the latest

44
Q

What may a broker do as a purchased option becomes closer to ITM?

A

Ask for collateral payments from client in case of exercise.

45
Q

What do FLEX options offer that OTC do not?

A

Limited credit/counterparty risk as they are centrally cleared

46
Q

What is the difference between callable and puttable bond?

A

Callable - issuer can buy back
Puttable - can be redeemed early

47
Q

What is an index linked note?

A

Instrument whose return is determined by a specific index

48
Q

What is a capital protected product?

A

Where investor borrows money to buy assets (e.g. warrants)
Assets become security for the loan

49
Q

How does ISDA help in default?

A

Close out all transactions covered by the master agreement, rather than individually - as they can be netted

50
Q

What are termination events?

A

In ISDA
External circumstances outside control of parties that allow deals to be terminated

51
Q

What are the 3 main issues covered by the ISDA master agreement?

A

Termination Events
Events of default
Netting

52
Q

What are the two types of netting in a master agreement?

A

Payment netting, netting amounts due in same currency
Close-out netting, converting all amounts to single termination currency

53
Q

What are the specific terms of each deal in an agreement called?

A

Confirmations

54
Q

What is a key attribute of collateral?

A

That it is easy to liquidate in a default

55
Q

What is the minimum transfer amount for collateral

A

Agreed between CPs for min amount to be transferred in case of market value changes

56
Q

What do master confirmations allow transactions to do?

A

Be electronically matched

57
Q

Where is collateral held?

A

Normally held in a third party account, not companies own account

58
Q

Why is collateral held in a third-party account?

A

Prevent the depositing counterparties assets being used to meet any liabilities

59
Q

What is MarkitSERV?

A

DTC Gateway for OTC derivatives trade processing

60
Q

What is SwapClear?

A

LCH Group
Clearing house function to OTC derivatives markets
Not STP

61
Q

What is the matching service that DTCC provides for OTC derivatives?

A

Deriv/SERV

62
Q

What is Omgeo OASYS

A

Screen affirmation platform that allows traders and front office staff to affirm trades

63
Q

What is Omgeo Central Trade Manager?

A

Platform for the central matching o cross-border and domestic transactions

64
Q

What does the NSCC National Securities Clearing Corporation do?

A

Act as a central counterparty, provides trade guarantees, netting and risk management services

65
Q
A