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L1 57 Derivative Markets and Instruments > Derivative Markets And Instruments > Flashcards

Derivative Markets And Instruments Flashcards

0
Q

Derivatives derive their values from the performance of these basic assets.

A

?

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1
Q

Derivative

A

Financial instruments that derives their values from the performance of an underlying asset

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2
Q

ETF derivatives

A

?

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3
Q

OTC derivatives

A

?

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4
Q

Forward commitments

A

?

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5
Q

Contingent claims

A

?

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6
Q

Distinguish derivatives from mutual funds, ETF’s and other ‘pass-through’ instruments

A

Derivatives transform the performance of the underlying asset before paying it out in the derivatives transaction.

Transformation is implicit

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7
Q

Derivatives take their value and certain other characteristics from the underlying asset.

A

Derivatives take their performance from an underlying asset.

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8
Q

Mutual funds and ETF’s ‘pass through’

A

The returns of their underlying securities

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9
Q

Derivative strategy performance

A

Derived from the underlying and the specific features of derivatives

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10
Q

Derivatives are similar to insurance

A

Transfer risk from one party to another

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11
Q

Insurance

A

A financial contract that provides protection against loss.

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12
Q

Insurance provides protection against loss

A

The party bearing the risk purchases an insurance policy, which transfers the risk to the insurer for a specified period of time. Risk itself does not change, the party bearing it does.

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13
Q

Underlying

A

Aka ‘underlying asset’, stocks and bonds

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14
Q

The out option when combined with a position exposed to risk

A

Functions almost exactly like insurance

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15
Q

An insurance contract must specify the ‘underlying risks’

A

Property, health, life

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16
Q

An underlying value

A

Is the source of risk

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17
Q

Common derivatives underlyings

A

Equities

Fixed income securities

Currencies

Commodities

Interest rates

Credit

Energy

Weather

Other derivatives

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18
Q

Derivatives are created in what form?

A

Legal contracts

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19
Q

Legal contracts

A

Two parties - the buyer and seller

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20
Q

Derivatives buyer

A

Long, the holder

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21
Q

Derivatives seller

A

Short, the writer

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22
Q

General classes of derivatives

A

Forward commitments

Contingent claims

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23
Q

The ability to lock in an underlyings buy or sell price

A

Forward commitments

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24
Q

the two parties must transact in the future at an underlying previously locked in price

A

Forward commitment

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25
Q

Types of forward commitments

A

Forwards contracts

Futures contracts

Swaps

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26
Q

The right but not obligation to buy or sell the underlying at a predetermined price

A

Contingent claims

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27
Q

‘Contingent’ claims

A

Choice of trade v. Inaction depends on a particular random outcome

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28
Q

Primary contingent claim

A

Option

29
Q

Derivatives serve to improve market the performance of the markets for the underlyings

A

?

30
Q

Derivatives characteristics

A

Higher degree of leverage relative to the value of the underlying

Lower transaction costs relative spot market transactions

More liquid than their underlyings

Risk transfer is simple, effective, and low cost

Easier to go short

31
Q

A relatively high degree of leverage

A

Participants may invest only a small amount of their own capital relative to the value of the underlying

32
Q

High leverage drawback

A

Small movements in the underlying can lead to large movements in gain or loss on a derivative

33
Q

Going short derivatives

A

Benefiting from a decline in the value of the underlying

34
Q

Spot markets

A

Where assets are traded for immediate delivery

35
Q

Shareholders trade a derivative on the equity

A

To reduce or completely eliminate the market exposure

36
Q

Holders of fixed income, to focus on credit risk or interest rate risk

A

Use derivatives to reduce or completely eliminate one risk to focus better on the other

37
Q

Types of performance transformations facilitated by derivatives

A

?

38
Q

Derivatives facilitate performance transformations in order to…

A

Allow market participants to practice more effective risk management

39
Q

A financial expert expects derivatives to result in

A

management of financial risk

40
Q

Risk management has taken a prominent role in financial markets

A

Large losses from trading, lending, or operations reflect how poorly a company manages risk

41
Q

Risk management does not guarantee that large losses will not occur

A

Unless the amount of risk taken is so small that the organization would be effectively constrained from pursuing its primary objectives (profit)

42
Q

Risk management process

A

Define a willing level of risk

Measure the effectual level of risk

Adjust the effectual risk level to match the willing risk level

43
Q

The best example of a derivative

A

A contract to purchase an equity share at a fixed price

44
Q

Not a characteristic of a derivative

A

A low degree of leverage

45
Q

Derivatives are not created in the spot market where

A

Underlyings trade

46
Q

Derivatives as risk management tools

A

Better adjust the level of risk than trading underlyings

47
Q

The overriding objective of derivatives

A

To manage risk

48
Q

Where do equities trade?

A

Organized exchange traded equity markets

OTC markets

49
Q

Exchange traded equity markets

A

Formal organizational structures that facilitate transactions between buyers and sellers together through market makers, or dealers

50
Q

Market makers

A

Stand ready to buy at one price and sell at a higher price

51
Q

Standardization of terms and an active market allow market makers to ‘scalp’

A

Ability to buy and sell almost simultaneously at different prices, locking in small, short term profits

52
Q

Exchange traded derivative contracts are standardized

A

Terms and conditions are precisely specified by the exchange aka there is very limited ability to alter those terms

53
Q

Standardized exchange traded derivatives markets make it easier to provide liquidity.

A

Market makers guarantee that derivatives can be bought and sold because contracts are well defined

54
Q

Cornerstones of exchange traded derivatives markets

A

Market makers

Speculators

55
Q

OTC derivatives are customized

A

?

56
Q

Historical difference between OTC and exchange

A

OTC - formally organized or refer to informal networks of parties who buy and sell with each other. Strictly electronic.

Exchange traded markets: brought buyers and sellers together in a physical location

57
Q

Informal OTC network of buyers who buy and sell with each other

A

Corporate and gov bond markets in the US

58
Q

A market maker is unable to scalp

A

Forced to hold exposed positions or layoff to speculators

59
Q

Lay off the risk

A

Trading (selling) off the risk to speculators

60
Q

Good speculators manage risk by watching their exposures, absorbing market information, observing the flow of orders to able to survive and profit or become uncomfortable speculator and…

A

…hedge risks

61
Q

Standardization facilitates creation of clearing and settlement operations

A

Which establish a critical flow of money in trading derivatives

62
Q

Clearing process

A

The exchange verifies transaction execution

The exchange records the participants identities

63
Q

Settlement process

A

The exchange transfers money from one participant to the other or between the participant and exchange

64
Q

A critical element of derivatives trading

A

The flow of money due to clearing and settlement

65
Q

Derivative exchanges relative to securities exchanges in clearing and settlement

A

Derivatives clear and settle over night. Securities exchanges require two business days.

66
Q

Exchange traded derivative markets provide a credit guarantee via clearinghouses because derivative contract engagements are zero sum

A

Clearinghouses pay the winner if the loser cannot by margin bond or performance bond

67
Q

Margin bond or performance bond

A

A cash deposit that provides a credit guarantee

68
Q

Exchange market benefits

A

Standardized

Highly liquid

Guaranteed credit

Transparent

69
Q

Exchange market transparency and standardization trade offs

A

Transparency discloses full information on all transactions to exchanges and regulatory bodies at the cost of privacy

Standardization provides liquidity at the expense of flexibility

70
Q

A critical element by which derivative exchanges are able to provide their services

A

Standardization

71
Q

3.2 - OTC Feb 11

A

Start

L1 57 Derivative Markets and Instruments (7 decks)

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