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Intro to Finance > Derivatives > Flashcards

Derivatives Flashcards

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1
Q

derivatives

A

a security which derives its value from the value or return on another asset or security

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2
Q

leverage

A

borrowing money in order to place a larger trade than the size of your account

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3
Q

initial margin

A

the amount of funds required in the account to initially open a trade

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4
Q

maintenance margin

A

the minimum amount of funds that must be maintained in the account to maintain the trade

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5
Q

if the account equity declines below maintenance margin, this triggers a

A

margin call, at which the investor must deposit funds to bring the account back up to the initial margin

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6
Q

forwards

A

one party agrees to buy a physical or financial asset on a specified date at a specified price
- can be used either for speculative purposes or to hedge a market risk

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7
Q

traded over the counter OTC

A

which means there is no using dealers with no central location
-largely unregulated
-each contract has a counterparty which exposes owner to default risk

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8
Q

futures

A

are the exact same as a forward with the following differences:
-futures are traded on organized exchanges
-futures are standardized
-futures have a clearinghouse which removes counterparty risk
-futures markets are regulated

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9
Q

types of futures/ forwards

A

commodity contracts
foreign exchange
indices
individual securities

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10
Q

commodity contracts

A

crude oil, corn, gold, soybean, etc

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11
Q

foreign exchange

A

EUR/USD, USD/JPY, GBP/EUR etc

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12
Q

indices

A

S&P 500, nasdaq

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13
Q

individual securities

A

apple, tesla, walmart etc

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14
Q

uses of the forward and futures market

A

hedging
speculation

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15
Q

hedging

A

using the market to reduce the volatility in a Company’s cash flows.
Example: a Company purchases aluminum, so they buy an aluminum future to lock in the price of their raw material

forward is mainly in hedging
forward is more meaningful in Company entities

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16
Q

speculation

A

an individual or firm purchases or sells a future in order to attempt to profit on price movement

most transactions in the futures market are for speculation

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17
Q

Arbitrage

A

A transaction in which an investor purchases one asset or a portfolio of assets at one price, and simultaneously sells an asset or portfolio that has the same future payoffs at a higher price. this generates risk-free gain

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18
Q

Risk free gain is capped at

A

the risk-free rate in the market. if there are arbitrage opportunities they are exploited quickly, driving the return to the market risk free rate

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19
Q

short:

A

selling an asset that you don’t actually have

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20
Q

future price=

A

spot price * (1 + RFR) ^ time

assumes no dividends or cost of storage

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21
Q

benefits of holding an asset

A

income outside of price appreciation. Dividends on stocks, coupon payments on bonds

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22
Q

costs of holding an asset

A

storage costs to hold a physical asset. Not typically associated with financial assets

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23
Q

net cost of carry

A

present value of benefits of holding an asset, minus the present value of the costs of holding an asset

24
Q

futures price=

A

(spot price - net cost of carry) * (1+RFR)^t

25
Q

options

A

-gives the owner the right, but not obligation, to either buy or sell an underlying asset at a given price for specified time
-the person purchasing the option will pay the seller, or “writer” of the option an up front payment, or “premium” for this right
-can be used for hedging, but primarily used for high-risk speculation

26
Q

options trading

A

call option
put option

27
Q

call option

A

the buyer has the right to buy an asset at a specified price, known as the strike price. a trader purchasing a call option is speculating that the price will increase above said price

28
Q

put option

A

the buyer has the right to sell an asset at a specified price, known as a strike price. a trader purchasing a put option is speculating that the price will decrease below said price

29
Q

writing an option

A

selling said option.

A person writing a call is speculating that the price will not increase above the strike price.

A person writing a put is speculating that the price will not decrease below the strike.

30
Q

premium

A

the price of the option.

The buyer pays this premium to the writer

31
Q

expiration

A

the date at which the option contract is no longer valid. If a call (put) option never rises above (declines below) the strike price, then the option expires worthless, and the writer has profited off the trade

32
Q

in the money

A

when exercising an option would produce a profit for the buyer

33
Q

out of the money

A

a call (put) is out of the money when the market price is below (above) the strike price

34
Q

at the money

A

a call/put is at the money when the market price is equal to the strike price

35
Q

American Option

A

Can be exercised on or before the expiration date
-would never be exercised, would instead be sold

36
Q

European Option

A

Can only be exercised on the expiration date

37
Q

factors which drive options pricing

A

price of the underlying asset
strike price
risk free rate
volatility of the underlying assets
time to expiration
costs and benefits of holding the asset

38
Q

price of the underlying asset

A

for call options, the higher the market price the higher the value of the option. the inverse is true for put options

39
Q

strike price

A

higher strike prices have a negative impact on the value of call options, and a positive impact on the value of put options

40
Q

volatility of the underlying assets

A

an increase in volatility increases both the value of the put and the call options

41
Q

time to expiration

A

the longer the time the more valuable the option

42
Q

costs and benefits of holding the asset

A

benefits of holding the asset decreases call values and increases put values. costs of holding the asset have the inverse effect

43
Q

put call parity

A

fiduciary call
protective put

44
Q

fiduciary call

A

a combination of a call option with a strike price of X, and a 0 coupon treasury bond with the same expiration date as the option.

The 0-coupond bond pays the same as the strike price

45
Q

protective put
(put call parity def)

A

a put option on a security, and the security itself

46
Q

put call parity equation

A

call + present value of strike= put + stock

47
Q

common options strategies

A

covered call
protective put
straddle
strangle
protective collar

long is to buy
short is always to sell

48
Q

covered call

A

write a call, long the stock

generate income selling the call. if the price increases, you just sell the stock you own

49
Q

protective put

A

long a put, long the stock

the put works as insurance against the stock price dealing

50
Q

straddle

A

long a call, long a put. Each have the same strike price

you expect the price to be volatile

51
Q

strangle

A

long a call, long a put, different strike prices. Both out of the money
-you expect significnat volatility

52
Q

protective collar

A

long the stock, long an out of the money put, short an out of the money call

you are giving up upside in order to protect the downside

53
Q

swaps

A

swaps are custom agreements to exchange a series of payments on periodic settlement dates over a certain period of time (ex: quarterly payments over 2 years)

-on the settlement dates, the payments are netted, so only one party makes a payment

traded OTC- largely unregulated

default risk/ counterparty risk is important- who do you trade with?

primarily comprised of institutional participants

54
Q

common types of swaps

A

interest rate swap
currency swap

55
Q

interest rate swap

A

one leg pays a fixed rate, the other pays a variable rate
-used by businesses to fix their borrowing costs
-used by fixed income portfolio managers to alter the duration of their portfolio

Intro to Finance (11 decks)

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