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CISI Capital Markets Programme: Derivatives > Chapter 5: Principles of OTC Derivatives > Flashcards

Chapter 5: Principles of OTC Derivatives Flashcards

1
Q

What are the Benefits of a Forward?

Compared to a future?

A
  • OTC
  • Flexibility
  • Wide range of underlying
  • Confidentiality
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2
Q

What is the Forward Rate Agreement?

A

Forward on an interest rate which is priced at the interest rate.

e.g. If R = 3%, then the FRA = 3%

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3
Q

How is this Spot Rate Broken Down? 1 : 1.3462/75

What are the numbers called (esecially in bold)

A

The lower case number are call then Big numbers
The highlighted numbers are known as the Pips or the bid offer spread

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4
Q

Take this Spot Rate, What are the Numbers Called? 1 : 1.3549/58

A

1 = Bid

1.3549 = Term / quoted

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5
Q

When Would you Add or Subtract a Forward Rate to a Spot Rate?

Why would you do this?

A

To widen the spread

i.e. 10/20 you would add, to widen the spread. But e.g. 30/20 you would subtract to widen the spread.

Look at which number is bigger.

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6
Q

What does Interest Rate Parity Provide?

Why does it exist?

A

It eliminates the possibility that an individual could arbitrage rates across different markets.

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7
Q

What is a Non-Deliverable Forward?

Defintion and what does this mean for an investor?

A

A CFD

It is a cash settled forward contract, whereby the contract currency is not delivered, it isntead the P/L of the contract, in a currency of ones choice.

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8
Q

What is the Definition of a Swap?

What are each of the payment streams called?

A

Where two counterparties exchange one stream of cash flow against another. These payment streams are called the legs of the swap.

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9
Q

What are the Components of a Swap?

There are 4, TTFS

A
  • The term (length of time)
  • The notional amount (size of the swap)
  • The frequency (how often payments are swaped)
  • A swap rate (fixed component of the swap)
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10
Q

What are Vanilla Swaps?

For interest rate swaps?

A

Agreements to exchange fixed for floating.

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11
Q

What are Basis Swaps?

For interest rate swaps?

A

Agreement to exchange floating for floating

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12
Q

What is a Swaption?

A

An OTC option on a swap.

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13
Q

What is a Payer Swap?

Who is this?

A

Long on the interest rate, agree to pay fixed.

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14
Q

What is a Receiver Swap?

long or short and fixed or variable.

A

Short on the interest rate, agree to pay variable.

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15
Q

What Happens When a Swap is Considered Amortising?

What happens over time?

A

The notional decreases over time.

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16
Q

What Happens When a Swap is Considered Accreting?

What happens over time?

A

The notional increases over time.

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17
Q

What Happens When a Swap is Considered a Roller Coaster?

What happens over time?

A

When the notional value goes up and down, over time.

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18
Q

What is an Asset Swap?

What can they be used to create.

A

It is a bond combined with an interest rate swap.

Can be used to create a synthetic floating rate note.

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19
Q

Why Would an Investor Enter into a Total Return Swap, Instead of Just Buying the Asset?

3 Reasons that make the asset difficult to get hold of.

A
  • Cost
  • Availibility
  • Liquidity
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20
Q

What is a Total Return Swap?

Definition.

A

A transfer of exposure on a portfolio, with out the actual purchase or sale.

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21
Q

What Occurs When the Asset on a Total Return Swap Falls in Value?

A

The receiver has to suck it up and pay the balance.

They are exposed to both positive and negative.

22
Q

What Benefit does a Falling Asset in a Total Return Swap, Reap the Payer?

The usual payer when it increases in value?

A

A free hedge, as the receiver will have to pay to net the loss.

23
Q

What is the Structure and Motivation of a Payer in a Total Return Swap?

A
  • May own a portfolio of assets where the beleive the portfolio may fall.
  • Total asset return exhanged and based on a interest rate and notional amount.
  • No longer exposed to uncertainty, and does not have to sell.
24
Q

What is the Structure and Motivation of a Receiver in a Total Return Swap?

A
  • Would like exposure of an asset without having to purchase.
  • Pays interest rate on notional amount, for exchange of the toal return for the asset.
  • Exposed to return, both positive and negative of the asset.
25
Q

What is a Commodity Swap?

How is it structured?

A

The producer pays a commodity index price in exchange for a fixed price.

25
Q

What Consitutes a Credit Event for a Credit Default Swap?

A
  • ** Default**
  • Significant fall in asset value
  • Bankruptcy
  • Debt restructuring
  • Merger / demerger
  • Government intervention

Highlighted are the main ones.

26
Q

What is a Physically Delivered Credit Default Swap?

What is the structure of the payout?

A

Bond exchnaged for bond value.

27
Q

What is a Cash Settled Credit Default Swap?

What is the structure of the payout?

A

Investors receive bond value less recovery rate.

28
Q

What are the Components of a Credit Linked Note?

A
  • A funded derivative
  • Transferring the risk of a debtor
  • Seller has no obligation to pay if a specified event occurs.
28
Q

What is an Average Strike Option?

A

Where the strike price of the option is not pre known, and is set on exercise as an average of the underlying asset price.

29
Q

What is a Structured Product?

Definition?

A

A security with an embedded derivative.

30
Q

What is a Callable Bond?

When might an issuer call this?

A

Can be redeemed early at the discression of the issuer (if rates are falling).

31
Q

What is a Puttable Bond?

When might a holder put this?

A

Can be redeemed early at the discretion of the holder (if rates are rising).

32
Q

What is a Convertible Loan Stock Bond?

A

A bond that is convertible into ordinary shares.

33
Q

What is a Convertible Gilt Bond?

A

A bond that is convertible into other gilts.

34
Q

What is an Index Linked Note?

A

A bond where both capital and coupon is linked to an inflation index.

35
Q

What is an Equity Linked Note?

A

A note where the yield determined by the performance of an equity.

36
Q

What is a Capital Protected Product?

A

0 coupon bond and a long option.

37
Q

What is a Cap?

What is it really, C = C ?

A

An OTC call on an interest rate or asset.

38
Q

What is a Floor?

What is it really, what do you put on the floor?

A

An OTC put on an interest rate or asset.

39
Q

What is a Collar?

How can these be free?

A

Is a cap and a floor combined, to limit volatility.

If they buy a cap and sell a floor, this offsets the premium and creates a nuetral position.

40
Q

What is ISDA?

What does this mean?

A

International Swaps and Derivatives Association.

41
Q

What are the Aims of ISDA?

There are 3?

A
  • Provide standard market terms
  • Minimise administration
  • Facilitate cross border selling
42
Q

What is an ISDA Master Agreement?

What does this contain?

A

Generic contract between 2 OTC parties that covers the essential details of the relationship.

43
Q

What is Highlighted in the Master Agreement?

A

What termination and default events may void the contract.
Netting off payments and positions (i.e are payments on mulitple contaracts paid gross or net, and if one contract is voided are they all or just that one).

44
Q

What is an ISDA Confirmation?

What does this entail?

A
  • Refer to the master agreement and set out specific terms of the deal.
  • Master confirmations are also possible which incorporates standard terms for specific types of transactions.
  • Can be very short
45
Q

What are Protocols in Financial Services?

Are these updated?

A

A term used to describe a set of documents widely use by the market e.g. master agreements

Yes, regularly updated to reflect legislation where necessary.

46
Q

What are Recent Developments with Trade Processing Services?

There are 2, pretty ** STRAIGHT ** forward.

A
  • Increasing use of electronic processing and clearing services
  • Greater communication between systems (improving STP)
47
Q

What are Examples of Trade Allocation Systems?

A

DTCCs, Omgeo, OASYS

48
Q

What are Examples of Trade Capture and Confirmation Systems?

A

MarkitWire / MarkitSERV

CISI Capital Markets Programme: Derivatives (11 decks)

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