derivatives Flashcards
why may derivatives be used?
Derivatives can be used to manage risk in a portfolio by providing a way to hedge against adverse movements in the market. For example, an investor may use futures contracts to hedge against fluctuations in the price of a commodity that they own, or options contracts to hedge against a decline in the value of a stock that they own.
Derivatives can also be used for speculative purposes, such as betting on the direction of the market or the performance of an underlying asset. However, derivatives are generally considered to be more complex and risky than other types of securities, and may not be suitable for all investors.
what is meant by Derivative security, give 3 examples
Derivative security: a financial asset that represents a claim to another asset
- Forwards
- Futures
- Options
what is a future contract?
A futures contract is the obligation to make or take delivery of the underlying asset at a predetermined price on a future date.
Futures price: the price for the underlying asset is determined today, but settlement is on a future date.
The futures contract specifies the quantity and quality of the underlying asset and how it will be delivered.
Futures contracts are traded on a wide variety of assets in four main categories, what are the categories?
- Agricultural commodities
- Metals and Energy
- Foreign currencies
- Financial futures
what does “long” mean in Futures Contracts
Long: a commitment to purchase the commodity on the delivery date.
what does “short” mean in Futures Contracts
Short: a commitment to sell the commodity on the delivery date.
what is “Profit to long “ in future contracts
Profit to long = Spot price at maturity - Original futures price
what is “Profit to short “ in future contracts
Profit to short = Original futures price - Spot price at maturity
what is meant by “futures contract are a zero-sum game”?
The futures contract is a zero-sum game, which means gains and losses of both parties net out to zero.
what are three trading methods
Electronic trading has mostly displaced floor trading.
The exchange acts as a clearing house and counterparty to both sides of the trade.
The net position of the clearing house is zero.
what is open interest
Open interest is the number of contracts outstanding.
what is an Initial Margin
funds or interest-earning securities deposited to provide capital to absorb losses
what is Marking to Market
each day the profits or losses from the new futures price are paid over or subtracted from the margin
what is Maintenance Margin:
an established value below which a trader’s margin may not fall
what is Margin Call
when the maintenance margin is reached, broker will ask for additional margin funds
