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Derivatives > Derivatives > Flashcards

Derivatives Flashcards

1
Q

What is a futures contract?

A

An agreement to buy or sell a specified quantity of a specific asset on a specified future date at a price agreed today

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2
Q

What does the long position of a future describe?

A

Buyer of a future

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3
Q

What does the short position of a future describe?

A

Seller of the future

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4
Q

How is the value of a future derived?

A

From the value of the underlying asset

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5
Q

What is the delivery date also known as?

A

Expiry date

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6
Q

What is a contingent liability in futures?

A

An investment position where an investor may lose more money than they originally invested

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7
Q

What is a CFD?

A

Contracts for difference - cash settled derivatives

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8
Q

What is a forward?

A

Forward is a deal between two parties NOT on an exchange (OTC)

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9
Q

In what market does a the long futures make money?

A

In a price rising market

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10
Q

In what market does a short future make money?

A

In a falling market

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11
Q

What is max loss and gain for a long future?

A

Max loss - price of future
Max gain - Unlimited

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12
Q

What is max loss and gain for a short future?

A

Max loss: Unlimited
Max gain: price of future

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13
Q

How do you close out a long position?

A

Selling - going short

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14
Q

What do Bulls believe?

A

Market will rise - so they buy (long)

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15
Q

What do bears believe?

A

Market will fall - so they sell (short)

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16
Q

What is a short hedge used for?

A

Used to remove the uncertainly of owning an asset e.g. sell a future

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17
Q

What is a long hedge used for?

A

Used to remove the uncertainly of not owning asset e.g buy a future

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18
Q

What is arbitrage?

A

When you make a risk free profit exploiting anomalies in the prices between 2 related but different markets

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19
Q

What is an option?

A

Right to buy or sell an underlying on or before a set date (optional)

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20
Q

What is a call option?

A

Right to buy the underlying

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21
Q

What is a put option?

A

Right to sell the underlying

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22
Q

What is the exercise (strike) price?

A

Price at which an option specifies the asset can be bought or sold

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23
Q

What is the option premium?

A

Price paid for the option

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24
Q

What is a European style option?

A

Can be exercised at expiry only

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25
Q

What is an American option?

A

Can be exercised at anytime up to expiry

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26
Q

What is a Bermudian option?

A

Can be exercised at expiry or on specific specified dates

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27
Q

What is an Asian style option?

A

Exercised at the average price over a set period of time

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28
Q

What is a flex contract?

A

Options providing the user the ability to negotiate maturity, exercise price and style of contract

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29
Q

What is a barrier (knock out/in) option?

A

Option is activated when underlying reaches a specified barrier

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30
Q

What is a binary (digital) option?

A

Pays a fixed amount or nothing

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31
Q

What is a look back (path dependant) option?

A

Where the holder can pick highest / lowest price over the period

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32
Q

What is a ratchet option?

A

Series of options in one package

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33
Q

What is a chooser option?

A

Holder can choose if it’s a put or call upon exercise

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34
Q

What is a compound option?

A

An option giving the right on another option

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35
Q

What is a contingent liability transaction?

A

Derivative where you may lose more money than originally invested

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36
Q

What is the shape of P/L for holder of a long call?

A

Flat and then sharp rise

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37
Q

What is the shape of P/L for holder of a long put?

A

Sharp down and then flat

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38
Q

What is the shape of P/L for writer of a short call?

A

Flat and then sharp down

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39
Q

What is the shape of P/L for writer of a short put?

A

Sharp up and then flat

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40
Q

What type of strategy is a long call? Max loss/gain and breakeven?

A

Bullish
Max Loss: Premium
Max Gain: unlimited
Breakeven: Strike + Premium

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41
Q

What type of strategy is a short call? Max loss/gain and breakeven?

A

Bearish / Neutral
Max Loss: Unlimited
Max Gain: Premium
Breakeven: Strike + Premium

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42
Q

What type of strategy is a long put? Max loss/gain and breakeven?

A

Bearish
Max Loss: Premium
Max Gain: Strike - Premium
Breakeven: Strike - Premium

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43
Q

What type of strategy is a short put? Max loss/gain and breakeven?

A

Bullish/ Neutral
Max Loss: Strike - Premium
Max Gain: Premium
Breakeven: Strike - Premium

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44
Q

How do you make a synthetic long call?

A

Long underlying + Long put

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45
Q

What is a highly geared option?

A

Smaller outlay, for a larger profit or loss e.g. OTM options

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46
Q

What is T Bill

A

UK Gov debt bond, usually up to 3 months. Zero coupon discount issuance

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47
Q

What is commercial paper?

A

Unsecured short dated company debt

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48
Q

What is a certificate of deposit?

A

Deposit with interest e.g. term deposit

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49
Q

Standard settlement for spot trades?

A

T + 2

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50
Q

How long can FX forwards be for?

A

Up to 12 months

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51
Q

What is the gilt edged market?

A

UK GOV Debt market

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52
Q

Life, coupon and settlement time for GILTS (UK)?

A

Up to 50 years
Semi annual
T+1

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53
Q

Life, coupon and settlement time for T bonds (US)?

A

T notes, 2-10
T bonds: Over 10
Semi annual
T+1

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54
Q

Life, coupon and settlement time for German Bonds?

A

Schatz: 1.75 - 2.25, Bobl: 4.5 - 5.5 Bund: 8.5 - 10
Annual
T+2

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55
Q

Life, coupon and settlement time for French bonds (OATS)

A

OATS - Up to 50
Annual
T+2

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56
Q

Life, coupon and settlement time for Italian bonds (BTP)

A

3 - 30
Semi Annual
T + 2

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57
Q

Life, coupon and settlement time for Japanese’s bonds (JGB)

A

Normal: 10, Superlong: 20
Semi annual
T+1 domestic
T+3 Cross border

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58
Q

For credit agencies what is a default rating?

A

Moody’s - C
S&P / Fitch - D

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59
Q

For credit agencies what is investment grade long term rating?

A

Moody’s: Aaa to Baa3
S&P and Fitch: AAA to BBB-

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60
Q

For credit agencies what is investment grade short term rating?

A

Moody’s: P1 - P3
S&P: A1 to A3
Fitch: F1+ to F3

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61
Q

What is the basic characteristics for equities?

A

Right to vote
Dividend
Right to surplus on winding up

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62
Q

What is a warrant?

A

Right to subscribe to new shares from a company at a fixed price on a future date

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63
Q

What is Gordon’s growth model?

A

Calculates share value based on discounting future dividends

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64
Q

What can impact supply and demand for agriculture?

A

Land / Weather / Tech / Gov / Transport

Wealth, Population, Taste/Trend

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65
Q

What is the main use and main source for Aluminium?

A

Aircraft, Packaging, Windows

US, Asia, Europe

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66
Q

What is the main use and main source for Copper?

A

Electronics / Buildings

Chile, US

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67
Q

What is the main use for Zinc?

A

Galvanised brass

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68
Q

What is the main use for Nickel?

A

Stainless steel

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69
Q

What is the main use for Lead?

A

Batteries, Added to Petrol

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70
Q

What is the main use for Tin?

A

Packaging

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71
Q

What is the main use for Gold?

A

Electronics, Jewellery, Investment

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72
Q

What is the main use for Silver?

A

Industry, Jewellery

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73
Q

Main use and sources for crude oil?

A

Fuel + Plastics
Brent, Dubai, West Texas

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74
Q

Main use and sources for natural gas?

A

Fuel + Manufacturing
Worldwide

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75
Q

Types of exotics?

A

Freight
Weather
Emissions
Crypto

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76
Q

Main products for derivatives?

A

Bonds
Commodities
Equities
Exoctics
FX
Interest rates

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77
Q

What is the tick size?

A

Minimum movement of a contract

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78
Q

What is the tick value?

A

Monetary value of one tick

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79
Q

What is ICE and how does it work?

A

Energy products, index, bonds and Interest
Electronic
ICE CLEAR

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80
Q

Who does the clearing for LSE?

A

LCH

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81
Q

What platform are trades done on for Euronext?

A

Optiq

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82
Q

How are trades cleared for Euronext?

A

LCH SA or Euro CCP

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83
Q

What is CBOT and how does it work?

A

Chicago Board of Trade, part of CME
open outcry and electronic
Agriculture, gold, interest

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84
Q

Who does CBOT have a joint trading agreement with?

A

SGX

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85
Q

What is CBOE?

A

Chicago Board Options Exchange
Largest US exchange trading

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86
Q

What is CME and how does it work?

A

Chicago Mercantile Exchange
Open outcry and electronic
Equities indices etc.

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87
Q

What does NYMEX trade?

A

Metal, Energy, oil

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88
Q

What is the role of an exchange?

A

Marketplace, ensuring a transparent market with reporting and published pricing

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89
Q

What is a principal trade?

A

Dealing for yourself (or firm)

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90
Q

What is an agency trade?

A

Firm isn’t taking a position but earns commission on the trade as a broker

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91
Q

What is a cross trade?

A

Broker can act for 2 clients with opposite matching trades

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92
Q

What is a general clearing member?

A

Clear for themselves, clients and non clearing members

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93
Q

What is an individual clearing member?

A

Clear for themselves and their clients

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94
Q

What is the order flow for open outcry system?

A

Order placement
Booth clerk (info carried across the floor)
Trade execution
Confirmation and matching
Registration

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95
Q

How are screen based orders usually ranked?

A

Price and then time

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96
Q

What is a market order?

A

At best order e.g. no price given

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97
Q

What is a limit order?

A

Specified volume, and no worse than price

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98
Q

What is a market if touched order?

A

Orders when price hits a certain point

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99
Q

What is an opening order?

A

Has to be executed during opening procedure

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100
Q

What is a closing order?

A

Closed during closing procedure

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101
Q

What is a limit or market on close order?

A

Standard order during the day, but closed out using best price if it reaches closing auction

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102
Q

What is stop order?

A

Close out the position if the market reaches a certain level

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103
Q

What is a good till cancelled order?

A

Order valid until expressly cancelled

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104
Q

What is Block trading facility?

A

Allows large deals to be agreed bilaterally on exchange (not at market price)

105
Q

What is a basis trading facility?

A

Market users can enter into a conditional contract using a futures contract and cash instrument

106
Q

What is an EFP?

A

Exchange futures for physical

107
Q

how is fair value of a future calculated?

A

Spot price + cost of carry

108
Q

Why would you do a cash and carry arbitrage?

A

Future is trading above fair value

109
Q

Why would you do a reverse cash and carry arbitrage?

A

Future is trading below fair value

110
Q

What is convergence for futures pricing?

A

Cost of carry reduces towards delivery date so futures prices trends towards the cash price

111
Q

What is the arbitrage channel?

A

Theoretical arbitrage might be possible, but needs to be sufficient benefits to be economic in practise due to fees etc.

112
Q

How is basis calculated?

A

Cash price - futures price

113
Q

Why is basis usually negative?

A

Futures prices usually more than cash price as it includes the cost of carry

114
Q

What is a contago market?

A

Negative basis, e.g. cash price less than futures price due to cost of carry

115
Q

What is backwardation?

A

Positive basis, e.g. cash price more than futures price

116
Q

Why might backwardation occur?

A

Temporary shortage of underlying
A Benefit to carry

117
Q

If the basis strengths what does it do?

A

Narrow

118
Q

If basis strengthens who gains / losses?

A

Short hedge - Gains
Long hedge - Loss

119
Q

Is basis weakens who gains / losses?

A

Short hedge - Loss
Long hedge - Gain

120
Q

How is cost of carry calculated for an equity?

A

Includes interest foregone minus the dividend yield

121
Q

What is the beta?

A

Sensitivity of the stock to movement in price

122
Q

What is a STIR?

A

Short term interest rate, CFD on interest

123
Q

How does a STIR move in relation to interest rates?

A

Inversely to interest rates

124
Q

If an investor thinks interest rates will increase should they buy or sell a STIR?

A

SELL

125
Q

What is nominal value of a STIR?

A

£500k

126
Q

How would you hedge a loan with a STIR?

A

Sell interest rate contracts (protects against rise in rate)

127
Q

How is the premium on an option calculated?

A

Intrinsic value + Time Value

128
Q

When is an option likely to be exercised?

A

When it is in the money

129
Q

If there is lots of volatility how is the time value affects?

A

Higher time value due to the higher uncertainty

130
Q

Who does the erosion of time act in favour of for an option?

A

Against the holder, as the asset is losing value each day

131
Q

What does delta measure?

A

Sensitivity of the underlying

132
Q

What does theta measure?

A

Time sensitivity

133
Q

What does vega measure?

A

Volatility sensitivity

134
Q

What does Rho measure?

A

Interest rate sensitivity

135
Q

What is the impact on call / put premiums if delta increases

A

Call - Increases
Put - Decrease

136
Q

What is the impact on call / put premiums if theta increases

A

Both increase

137
Q

What is the impact on call / put premiums if vega increases

A

Both increase

138
Q

What is the impact on call / put premiums if rho increases

A

Call - Increases
Put - Decreases

139
Q

What is the impact on call / put premiums if dividends increases

A

Call - Decrease
put - Increase

140
Q

What is the Black- Scholes methodology for premium?

A

Volatility + Time + price + exercise price + interest rate + dividends = premium

141
Q

Alternative to black scholes model?

A

Binomial model

142
Q

When is time value greatest?

A

When the option is at the money

143
Q

How is delta calculated?

A

Change in value of premium / change in value of underlying

144
Q

For ITM call options what is delta?

A

Long +1
Short -1

145
Q

For ATM calls options what is delta?

A

Long +0.5
Short -0.5

146
Q

For ITM put options what is delta

A

Long -1
Short +1

147
Q

What is an options gamma?

A

How sensitive the delta is to a change in the underlying asset value

148
Q

What does put call parity explain?

A

Relationship between premium of a call and put option on the same
Underlying asset, strike price and expiry

149
Q

What is put call parity equation?

A

C - P = S * K/(1+R)^t

Call premium - Put Premium
Asset price * strike price / interest time

150
Q

What is assignment of trades?

A

Placing trades in the appropriate account

151
Q

What is allocation of trades?

A

Allocation is when traders under take trades on behalf of other firms. Executing broker gives up to the clearing broker

152
Q

What is the key difference between a forward and future?

A

Forwards are OTC

153
Q

What is a FRA?

A

Forward rate agreement
OTC interest rate future

154
Q

If you are long a FRA what happens?

A

Pay a fixed rate and receive a variable rate, pays out if interest rates rise

155
Q

If you are short a FRA what happens?

A

Receive a fixed rate and pay a variable rate, pays out if interest rates fall

156
Q

What decimal point is a PIP quotes from

A

4th and 5th decimal

157
Q

How do you know to add / takeaway for FX forward?

A

Forward rate will be a greater spread than the spot rate

158
Q

What is the interest rate parity equation?

A

1 + r variable / 1 + r base

159
Q

What is a currency swap possible for?

A

Fixed interest in one for floating in another
Fixed to fixed or floating to floating

160
Q

What is an interest rate swap?

A

Agreement to swap payments on loans

161
Q

How are payments paid out for an interest rate swap?

A

Netted payments

162
Q

What is a basis swap?

A

Floating rate swapped for a different floating rate

163
Q

Who is the payer on an interest rate swap?

A

The person who agreed to pay fixed - they are long the interest

164
Q

How are cross currency swaps executed?

A

Notional principle changes hands and payments are not netted

165
Q

What is a CAP?

A

OTC call option

166
Q

What is a total return swap?

A

When investor makes payments linked to total return of a referenced asset without actually owning the asset

167
Q

What is a synthetic equity fund?

A

Investor gains exposure to the equity without actually owning it

168
Q

What is a CDS?

A

Credit default swap, insurance on an asset

169
Q

When does the buyer of a CDS gain?

A

In a credit event e.g. significant fall in price, default event, gov intervention etc

170
Q

What is a CLN?

A

Credit linked note allows the institution to protect from the default of the debtor by selling on the debt

171
Q

The real time prices shared by the exchange usually show what?

A

Current prices best bid and ask
Last trade
Days high and low
Volume and open interest

172
Q

Why do firms monitor open positions?

A

To prevent unwanted delivery situations

173
Q

What does the ISDA do?

A

Bring together all OTC trades into one agreement

174
Q

Main pieces agreed in an ISDA?

A

Termination Events
Default Events
Netting Off

175
Q

What takes precedent the confirmation or ISDA

A

Confirmation

176
Q

What is a CSA?

A

Register the criteria for collateral payments

177
Q

What is master give up agreement?

A

Documents the relationship between dealer and prime broker

178
Q

What is a deal ticket for OTC trades?

A

Effectively a trade report made after the trade is agreed

179
Q

What is counterparty risk in derivatives?

A

Risk that once contract is agreed at least one party doesn’t meet the obligations

180
Q

What is the clearing house guarantee principal to principal?

A

Guarantees its members obligations in relation to trades it clears for them

181
Q

What is an independent clearing house guarantee?

A

Backed by clearing house resources

182
Q

What is an mutual clearing house guarantee?

A

Backed by clearing house and its members

183
Q

What is a Novation of a trade?

A

Clearing house becomes middle party between trades (sell / buy) counterparty

184
Q

What is a position limit?

A

Set by some exchanges to stop one firm establishing a dominant position in the market

185
Q

What are exchange price limits?

A

Limits to prevent the prices moving too far or fast in a trading session

186
Q

What is initial margin?

A

Paid on contingent liability transactions, a returnable good faith deposit

187
Q

What is SPan?

A

Calculation for initial margin - based on worst case scenario 1 day loss

188
Q

What is intra day margin?

A

If market become volatile additional margin may be demanded at short notice

189
Q

What is variation margin?

A

Accounts for prior days movements from open positions

190
Q

When is VM paid?

A

Next business day (based on previous days movements)

191
Q

How do holders of options pay VM?

A

No need to - premium paid up front

192
Q

Does the writer of an option pay margin?

A

Yes they pay initial margin

193
Q

When are premiums on options for futures typically paid?

A

Exercise or expiry

194
Q

Do you pay VM on options on futures?

A

YES

195
Q

What is TIMS?

A

Theoretical intermarket margining system

196
Q

Names of IM / VM for OCC?

A

Risk margin and premium margin

197
Q

What is a margin call?

A

In the event of the balance on IM account falling to a set level, clearing house will make a margin call - need to top back up to original level

198
Q

What is the broker margin?

A

Margin brokers demand from their clients, got to be at least equal to clearing house margin

199
Q

How are VM calls paid?

A

Cash

200
Q

How are IMs typically paid

A

Lodging collateral with custodian, usually with a haircut and MTM

201
Q

Types of acceptable collateral for UK clearing houses?

A

Cash, Bank Guarantee, UK debt (not EUR GILTS), EU debt and deposit certs (£ and $)

202
Q

What is the threshold amount?

A

Max unsecured credit exposure taken

203
Q

What is the minimum transfer amount?

A

Reduces cost by setting a minimum amount of collateral to be transferred

204
Q

What is CSA?

A

Sets out rules / conditions for collateral to be transferred

205
Q

What is collateral support docs?

A

Timings and procedures for MTM

206
Q

What are the uncleared margin rules?

A

Principle based rules on non centrally cleared OTC derivatives

207
Q

What is the threshold for UMR?

A

Aggregate average notional amount of uncleared contracts e.g. 8bn

208
Q

What is principles based UMR?

A

Must exchange VM/IM
High quality collateral
Reg approved methodology
Segregation of assets

209
Q

What is ISDA SIMM?

A

Approved method for calculating initial margin

210
Q

3 options for holders of futures contracts

A

Close out
Roll forward
Proceed to delivery

211
Q

What is EDSP?

A

Exchange delivery settlement price - price at which underlying changes hands on the delivery date

212
Q

How are CFDs delivered?

A

Cash, difference between EDSP and previous days settlement price

213
Q

What is the invoice amount?

A

Amount the long pays for the physically delivered asset

214
Q

How is the invoice amount calculated?

A

EDSP x Number of Contracts x Contract size

215
Q

Who send the exercise notice?

A

Broker to LCH once holder informs them of intention to exercise

216
Q

Who send Assignment notice?

A

Clearing house randomly picks a writer to send an assignment notice to once they receive the exercise notice

217
Q

What is automatic exercise?

A

Clearing house can turn on automatic exercise if desired to ensure ITM transactions are not forgotten

218
Q

What is an inter market spread?

A

Buying correlated futures simultaneously on different assets with the same delivery dates

219
Q

What is an intra market spread

A

Buying and selling the same future with different expiries to make a profit

220
Q

What are intra market strategies?

A

Trade the spread
Reduce risk
Arbitrage
Roll over existing positions

221
Q

What is a synthetic long?

A

Short put + Long call to get one straight upward line

222
Q

What is a synthetic short?

A

Long put and short call to get one long downward line

223
Q

How do you do a covered call?

A

Long underlying and a short call

224
Q

What is the motivation for a covered short call?

A

Enhance returns in a stagnant market and partly hedge the long underlying position

225
Q

Features of a covered call?

A

Downside protection
Return if share price is unmoved
Return if option exercised

226
Q

What is the motivation for a covered short put?

A

Enhance returns in a stagnant market and partly hedge short position

227
Q

How do you do a covered short put?

A

Short underlying and short buy position

228
Q

What are derivative combinations?

A

Strategies with a call and a put

229
Q

What is a long straddle shape?

A

Big V

230
Q

What is strategy for a long straddle?

A

High volatility

231
Q

Breakeven and max loss on a straddle?

A

Breakeven = Strike and premium
Max loss = both premiums

232
Q

What is strategy for a short straddle?

A

Low volatility

233
Q

Breakeven and max profit on a short straddle?

A

Breakeven = Strike and premium
Max profit = both premiums

234
Q

Shape of a short straddle?

A

Arrow up

235
Q

What is a strangle?

A

Like a straddle but both options have different strikes

236
Q

Breakeven for strangle?

A

Strike +- both premiums

237
Q

Strategy for a short strangle?

A

Low volatility, max profit is only both premiums

238
Q

What is an option spread?

A

2 calls or 2 puts (must be the same!!)

239
Q

What is a vertical option spread?

A

Taking advantage of different strikes between 2 calls (or 2 puts)

240
Q

What is a horizontal spread option?

A

Taking advantage of difference between 2 calls (or 2 puts) across different expiries

241
Q

What is a diagonal spread?

A

Taking advantage of different strikes between 2 calls (or 2 puts) across different expiries

242
Q

What is a bull call vertical spread?

A

Long underlying with higher premium
Short call with lower premium

243
Q

What is a bear call vertical spread?

A

Short underlying with higher premium
Long call with lower premium

244
Q

Types of investors and their objectives for derivatives?

A

Retail - limited
HNW - not overly speculative
Corporate - Hedging
Asset managers - Hedging and speculation
Hedge Funds - speculative

245
Q

What are the purpose of regulators?

A

Orderly markets
Consumer protection
Fight crime
Reduce systemic risk

246
Q

What does MIFID do?

A

Harmonise rules governing EEA
Passporting
Set Capital Requirements Directive

247
Q

What does MIFID II do?

A

Increased scope and increased protection
Emphasis on corp governance
More trading venues covered

248
Q

What is the transparency directive?

A

Establishes minimum financial reporting requirements and disclosures for shareholders to be admitted on to EU regulated market

249
Q

What is best execution?

A

Obligation to execute on terms most favourable to the client

250
Q

What is client asset protection?

A

Segregate assets from firms own assets and reconcile as often as necessary

251
Q

What is FINRA?

A

Financial Industry Regulatory Authority, regulates firms dealing in securities

252
Q

Who regulates the US securities market?

A

SEC

253
Q

Who regulates the US derivatives market?

A

CFTC

254
Q

What is the NFA

A

National futures association, SRO that regulates firms dealing in the derivatives market

255
Q

What is Part 30 of the commodities exchange act?

A

For a firm to deal on behalf of a US investor on a US derivatives Exchange they must be fully registered with the CFTC and NFA

256
Q

What is a Part 30 exemption?

A

Allows a Non US Firm to deal with US investors dealing on non US exchanges

257
Q

How do US rules on asset segregation differ to UK?

A

All clients money in US must be segregated. In the UK, professional clients can opt out of segregation

258
Q

How do the rules on 2 way consent differ between UK and US?

A

UK only retail clients need to sign a client agreement and risk warning

US all clients must sign these

259
Q

What did the Dodd frank act do?

A

Mandatory electronic confirmations and central clearing

Derivatives (1 decks)

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