Derivatives Flashcards

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1
Q

Derivative Markets: Derivatives

A
  • A derivative security derives its value from the price of another (underlying) asset or an interest rate
  • Futures and some options are traded on organized exhanges
  • Forward contracts, swaps, and some options are custom instruments created by dealers
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2
Q

Derivative Markets: Forward Commitments and Contingent Claims

A
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3
Q

Derivative Markets: Forward Contracts

A
  • Customized: No active secondary market
  • Lond obligated to buy; short obligated to sell
  • Specified asset (currency, stock, index, bond)
  • Specified date in the future
  • Long gains if asset price is above forward price
  • Short gains if asset price is below forward price
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4
Q

Derivative Markets: Futures Contracts

A
  • Like forward constract but standardized
  • Exchange-traded, active secondary market
  • Require margin deposit
  • No defauly (counterparty) risk
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5
Q

Derivative Markets: Swaps

A
  • Equivalent to a series of forward constracts
  • Simple interest rate swap
  • One party pays a fized rate of interest
  • One party pays a variable (floating) rate of interest
  • Payments can be based on interest rates or stock/portfolio/index returns
  • Can involve 2 different currencies
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6
Q

Derivative Markets: Purpose and Criticism of Derivative

A
  • Derivatives are criticized as being risky and likened to gambling
  • Benefits of derivatives markets
    • Provide price information
    • Lower transaction costs
    • Allow the transfer of risk
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7
Q

Derivative Markets: Role of Arbitrage

A
  • Arbitrage is possible when two securities or portfolio have identical future payoffs but different marker prices
  • Trading by arbitrageurs will continue until they affect supply and demand enough to bring asset price to efficient (no-arbitrage) levels
  • Arbitrage relations are used to value derivatives
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8
Q

Forwards: Forward Contract Positions

A

Long position (will buy)

The party to the forward constract that agreees to buy the underlying or physical asset

Short position (will sell)

The party to the forward contract that agrees to sell/deliver the asset

Neither party pays at contract initiation

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9
Q

Forwards: Forward Contract Settlement

A
  • Delivery: Short delivers underlying to long for payment of the forward price
  • Cash settlement: Negative side of contract pays the positive side
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10
Q

Forwards: Early Termination of Forward

A
  1. One party pays the other cash (buys their way out)
  2. Enter into an offsetting contract
    • With a different coutnerparty (Default risk still exists)
    • With same (origianl) counterparty (no default risk)
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11
Q

Forwards: Dealers and End Users of Forwards

A
  • A dealer creates a derivative contract and will quote a price to take a long or short position
  • An end user is typically a corporation or institution seeking to transfer an existing risk
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12
Q

Forwards: Equity Forward Contracts

A
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13
Q

Forwards: Equity Index Forward - Problem

A
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14
Q

Forwards: Forward on Zero-Coupon Bonds - Example

A
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15
Q

Forwards: LIBOR-Based Loan Example

A
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16
Q

Forwards: FRA

A

Forward Rate Agreement (FRA)

Exchange fixed-rate for floating-rate payment

  • Notional amount
  • Fixed rate = forward (contract) rate
  • Floating rate (LIBOR) is underlying rate
  • Long gains when LIBOR > contract rate

Long position can be viewed as the obligation to take a (hypothetical) loan at the contract rate(i.e. borrow at the fized rate); gains when reference rate increases

Short position can be views as the obligation to make a (hypothetical) loan at the contract rate (i.e. lend at the contract rate; gains when reference rate decreases

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17
Q

Forwards: FRA - Example

A
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18
Q

Forwards: FRA Settlement Payment to Long

A
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19
Q

Forwards: Currency Forward Contracts

A
  • Currency forward contracts are committment to buy or sell a certain amount of a foreign currency for a fixed amount of another currency in the future
  • As with other forwards, cash settlements is the amount necessary to compensate the party who would be disadvantaged by the actual change in market rate as of the settlement date
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20
Q

Futures: Chacteristics

A
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21
Q

Futures: Forwards vs. Futures

A
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22
Q

Futures: Margin Terms

A
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23
Q

Futures: Trade - Example

A
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24
Q

Futures: Price Limits

A
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25
Q

Futures: Marking-to-Market

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26
Q

Futures: Margin Calculation Example

A
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27
Q

Futures: Methods to Terminate a Futures Position at Expiration

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28
Q

Futures: Closing a Futures Trade by Offset

A
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29
Q

Futures: Contract Delivery Options

A
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30
Q

Futures: Eurodollar Futures

A
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31
Q

Futures: Treasury Bond Futures

A
32
Q

Futures: Stock Index Futures

A
33
Q

Futures: Currency Futures

A
34
Q

Options: Basics

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35
Q

Options: Terminology

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36
Q

Options: Moneyness

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37
Q

Options: Call Option - Example

A
38
Q

Options: Put Option - Example

A
39
Q

Options: Exchange-Traded vs. OTC Options

A
40
Q

Options: Underlying Assets

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41
Q

Options: Interest Rate Options

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42
Q

Options: Two Interest Rate Option = One FRA - Graph

A
43
Q

Options: Interest Rate Caps and Floors

A
44
Q

Options: Cap and Floor Payoffs

A
45
Q

Options: Interest Rate Option - Problem

A

.

46
Q

Options: Value

A
47
Q

Options: Notation

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48
Q

Options: Minimum and Maximum Values

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49
Q

Options: Differ by Exercise Price

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50
Q

Options: Deriving Put-Call Parity (European Options)

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51
Q

Options: Parity Conditions and Synthetic Options

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52
Q

Options: Put-Call Parity - Problem

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53
Q

Options: Time, Volatility, RFR, and Stock Price

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54
Q

Options: Cash Flows on the Underlying Asset

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55
Q

Swaps: Overview

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56
Q

Swaps: Characteristics

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57
Q

Swaps: Terminology

A
58
Q

Swaps: Termination

A
59
Q

Swaps: Currency Swaps - Example

A
60
Q

Swaps: Plain Vanilla Interest Rate Swap

A
61
Q

Swaps: Plain Vanilla Interest Rate Swap - Formula

A
62
Q

Swaps: Fixed-for-Floating Swap Example

A
63
Q

Swaps: Equity Swaps

A
64
Q

Swaps: Equity Swaps - Example

A
65
Q

Swaps: Equity Swaps - Problem

A
66
Q

Risk Management: Call Intrinsic Value/Payoff at Expiration

A
67
Q

Risk Management: Profit and Loss: Call Options

A
68
Q

Risk Management: Put Intrinsic Value/Payoff at Expiration

A
69
Q

Risk Management: Profit and Loss: Put Options

A
70
Q

Risk Management: Call Profit and Loss - Problem

A
71
Q

Risk Management: Covered Call Strategy

A
72
Q

Risk Management: Covered Call - Problem

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73
Q

Risk Management: Payoffs and Profits - Covered Call

A
74
Q

Risk Management: Protective Put Strategy (Position)

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75
Q

Risk Management: Protective Put - Example

A
76
Q

Risk Management: Profit and Payoff - Protective Put

A