Chapter 6 Derivatives Flashcards
What is a derivative?
A financial instrument whose price is based on the price of another asset.
What is an underlying asset in the context of a derivative?
The asset which the derivative’s price is based upon.
What is hedging?
A technique used by fund managers to reduce the impact of negative movement on a portfolio’s value.
What are two forms of hedging?
Selling futures contracts
Buying put options
What is a vital part of hedging? (Hint, cash)
Anticipating future cash flows, where portfolio managers expect to receive a large inflow of cash to be invested in a particular asset.
What is an asset allocation change?
Changes to where assets are allocated in a fund.
What is arbitrage?
The process of deriving a risk-free profit from simultaneously buying and selling the same asset in two different markets. Essentially matched betting.
What is a future?
An agreement between buyer and seller to exchange money for the delivery of an asset at a future date.
What are the two distinct features of a futures contract?
It is exchange traded on a derivative exchange
It is dealt on standardised terms, specifying the quality of the underlying asset, the future date and the delivery location.
What does being long mean?
Being committed to buying the underlying asset at the pre-agreed price on the specified date.
What does being short mean?
Being committed to delivering the underlying asset on the delivery date. (position of the seller)
What does being open mean?
The initial trade, essentially ‘opening’ a position.
What does close mean?
The physical assets that futures are traded based on don’t usually get delivered, so are closed instead. E.g. crude oil.
What is being covered?
When the seller of the future actually has the underlying asset that will be needed if physical delivery takes place.
What is being naked?
When the seller of the future does not have the asset that will be needed if physical delivery takes place.
