Definitions Flashcards
Hedging?
Hedgers want to reduce their risk and they do so by paying speculators a premium to take this risk from them.
Together, they have a contract (derivative contract)
Arbitrage?
People make an arbitrage profit by buying from where it is cheap and selling where it is more expensive. As a result, they earn riskless, costless profit by trading. This action drives the market towards equilibrium.
Leveraging?
When you maximise your risk and return
Futures contracts
A contract between two parties to trade at a future date, at a price agreed upon today.
Forward contracts
A contract between two parties to trade at a future date, at a price agreed upon today.
Swaps
A swap is a contract in which two parties agree to exchange cash flows
Options
An option is a contract that gives you the right to sell or buy a specified asset at an agreed price, at some point in time.
There are two types of option contracts:
1. call option
2. put option
What is meant by Intrinsic Value?
The part of an options value that comes from its immediate usability or exercise potential
What is meant by Time Value?
The extra value an option has beyond its intrinsic value. It represents the potential for the option to become more valuable before it expires
What is meant by put-call parity?
The relationship between prices of European call and put options
What are synthetic securities?
Any pattern of payoffs at expiry can be created by a suitable combination of puts, calls, assets and bonds.
e.g. a put-call parity is an example of a synthetic stock futures
What is the single-period binomial model?
It is a simple and intuitive approach to pricing options, and is particularly useful for understanding the basic concepts of option pricing
What is meant by risk neutral valuation?
Investors are indifferent even if they are at point Cu or Cd.
The model makes sure that no matter what point, overall, your portfolio will bring you a return at rate ‘r’.
What is the black-scholes Merton model?
Black-Scholes -Merton model is a measure used to calculate the theoretical price of European-style options
