Chapter 6 Flashcards
Their origins can be traced back to…., where farmers needed a mechanism to guard against price fluctuations caused by gluts of produce
agricultural markets
in order to fix the price of agricultural products produce in advance of harvest time, farmers and merchants enter into
forward contracts
these set the price at which a stated amount of a commodity would be delivered between a farmer and a merchant at a pre specified future date
forward contracts
worlds first derivatives
Chicago Board of Trade (CBOT) 1848
are where raw or primary products are exchanged or traded on regulated exchanges
commodity markets
is one when not only the amount and timing of the contract conforms to the exchanges norm, but also tge quality and form of the underlying asset
stardardized contracts
are sold by producers and purchased by consumers
commodities
much of the buying and selling is undertaken via.. which also offer the ability for producers and consumers to hedge their exposure to price movements
commodity derivatives
is a financial instrument whose price is based on the price of another asset, known as the underlying
derivatives
underlying could be
financial asset
commodity
currency
index
examples of financial assets
bonds
shares
examples of commodities
oil
gold
silver
corn
wheat
can take place either directly between counterparties or on an organized exchange
trading of derivatives
when trading takes place directly between counterparties it is referred to as
over the counter trading
when it takes place on an exchange, such as the NYSE the derivatives are referred to as being
exchange traded
it plays a major role in the investment management of many large portfolios and funds
derivatives
derivatives are used for
hedging
anticipating future cash flows
asset allocation change
arbitrage
this is a technique employed by portfolio managers to reduce portfolio risk, such as the impact of adverse price movements on a portfolios value
hedging
this could be achieved by buying or selling future contracts, buying put options or selling call options
hedging
closely linked to the idea of hedging, if a portfolio manager expects to receive a large inflow of cash to be invested in a particular asset, then futures can be used to fix the price
anticipating future cash flows
chnages to the asset allocation of a fund, whether to take advantage of anticipated short term directional market movements
asset allocation changes
the process of deriving a risk free profit from simultaneously buying and selling the same asset in two different markets when a price difference between the two exists
arbitrage
involves assuming additional risk in an effort to make, or increase, profits in the portfolio
speculation
forms of derivatives
forward
futures
options
swaps
it enabled standardized qualities and quantities of grain to be traded for a fixed future price on a stated delivery date
future contract
have subsequently been extended to a wide variety of commodities and are offered by an ever increasing nunber of derivatives exchanges
future contract
when was CBOT introduced the worlds first financial futures contract
1975
provides a mechanism by which the price of assets or commodities can be traded in the future at a price agreed today
derivatives
is a legally binding agreement between a buyer and a seller.
future
a future contract has two distinct features
It is exchange traded
it is dealt in standardized terms
the exchange specifies the quality of the underlying asset, the quantity underlying each contract, the future date and the felivery location
it is dealt on standardized terms
key terms that the futures market uses
long
short
open
close
the term used for the position taken by the buyer of the future
long
the person who is… in the contract is committed to buying the underlying asset at the pre-agreed price on the specified future date
long
the position taken by the seller of the future
short
it is commited to delivering the underlying adset in exchange for the preagreed price on the specified future date
short
it is the initial trade
open
it could be buying a future or selling a future
open
the physical assets underlying most futures that are opened do not end up being delivered thay are..
close
when does option pricing model start
1973
did not really start to flourish until two US academics produced an option pricing model
options
CBOE
Chicago Board Options Exchange
LIFFE
London International Financial Futures and Options Exchange
can also be traded off exchange or OTC, where the contract specification determined by the parties is bespoke
Options
it gives a buyer the right, but not the obligation, to buy or sell a specified quantity of an underlying asset at a pre agreed exercise price, on or before a prespecified future date or between two specified datee
option
main classes of option
call option
put option
it is when the buyer has the right to buy the asset at the exercise price, if they choose to
call option
it is when the buyer has the right to sell the underlying asset at the exercise price
put option
the seller is obliged to deliver if the buyer exercises the option
call option
the seller is obliged to take delivery and pay the exercise price, if the buyer exercises the option
put option
the buyers of options are the owners of those options and they are also referred to qs
holders
is the money paid by the buyer to the writer at the beginning of the options contract, it is not refundable
premium
is an agreement to exchange one set of cash flows for another
swap
are a form of OTC derivative and are negotiated between the parties to meet their different needs, so each tends to be unique
swaps
are the most common forn of swaps
interest rate swaps
they involve an exchange of interest payment and are usually constructed
swaps
one leg of the swaps is the payment of… and the other leg is a payment of
fixed rate of interest
floating rate interest
the two exchanges of cash flow are known as the
legs of the swaps
are instruments whose value depends on agreed credit events relating to a third party company
credit derivatives
defined as including a material default, bankruptcy, a significant fall in an assets value, or debt restructuring for a specified reference asset
credit events
the purpose of this is to enable an organization to protectitself against unwanted credit exposure by passing that exposure on to someone else
credit derivatives
can also be usee to increase credit exposure in return for income
credit derivatives
is actually more like an option
CDS
distinct groups of derivatives
OTC derivatives
exchange traded derivatives
are ones that are negotiated amd traded privately between parties without the use of an exchange
OTC derivatives
example of products that are traded in OTC derivatives
interest rate swaps
is the larger of the two in terms of value of contracts traded daily
OTC market
are ones that have standardized features and can therefore be traded on an organized exchange, such as single stock or index derivatives
exchange traded derivatives
examples of lending derivatives exchanges are
CME
ICE
LME
Eurex
the main derivatives exchange in the US
CME group
it is the worlds largest and most diverse derivatives exchanges
CME
it operates a number of exchanges and trading platforms
ICE
LME
london metal exchange
it trades derivatives on non-precious, non-ferrous metals, such as copper, aluminum and zinc
LME
is based in frankfurt germary
Eurex
its principal products are german bond futures and oltions, the most well known of which are contracts on the bund
Eurex
