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
2
Q
What does the long position of a future describe?
A
Buyer of a future
3
Q
What does the short position of a future describe?
A
Seller of the future
4
Q
How is the value of a future derived?
A
From the value of the underlying asset
5
Q
What is the delivery date also known as?
A
Expiry date
6
Q
What is a contingent liability in futures?
A
An investment position where an investor may lose more money than they originally invested
7
Q
What is a CFD?
A
Contracts for difference - cash settled derivatives
8
Q
What is a forward?
A
Forward is a deal between two parties NOT on an exchange (OTC)
9
Q
In what market does a the long futures make money?
A
In a price rising market
10
Q
In what market does a short future make money?
A
In a falling market
11
Q
What is max loss and gain for a long future?
A
Max loss - price of future
Max gain - Unlimited
12
Q
What is max loss and gain for a short future?
A
Max loss: Unlimited
Max gain: price of future
13
Q
How do you close out a long position?
A
Selling - going short
14
Q
What do Bulls believe?
A
Market will rise - so they buy (long)
15
Q
What do bears believe?
A
Market will fall - so they sell (short)
16
Q
What is a short hedge used for?
A
Used to remove the uncertainly of owning an asset e.g. sell a future
17
Q
What is a long hedge used for?
A
Used to remove the uncertainly of not owning asset e.g buy a future
18
Q
What is arbitrage?
A
When you make a risk free profit exploiting anomalies in the prices between 2 related but different markets
19
Q
What is an option?
A
Right to buy or sell an underlying on or before a set date (optional)
20
Q
What is a call option?
A
Right to buy the underlying
21
Q
What is a put option?
A
Right to sell the underlying
22
Q
What is the exercise (strike) price?
A
Price at which an option specifies the asset can be bought or sold
23
Q
What is the option premium?
A
Price paid for the option
24
Q
What is a European style option?
A
Can be exercised at expiry only
25
What is an American option?
Can be exercised at anytime up to expiry
26
What is a Bermudian option?
Can be exercised at expiry or on specific specified dates
27
What is an Asian style option?
Exercised at the average price over a set period of time
28
What is a flex contract?
Options providing the user the ability to negotiate maturity, exercise price and style of contract
29
What is a barrier (knock out/in) option?
Option is activated when underlying reaches a specified barrier
30
What is a binary (digital) option?
Pays a fixed amount or nothing
31
What is a look back (path dependant) option?
Where the holder can pick highest / lowest price over the period
32
What is a ratchet option?
Series of options in one package
33
What is a chooser option?
Holder can choose if it’s a put or call upon exercise
34
What is a compound option?
An option giving the right on another option
35
What is a contingent liability transaction?
Derivative where you may lose more money than originally invested
36
What is the shape of P/L for holder of a long call?
Flat and then sharp rise
37
What is the shape of P/L for holder of a long put?
Sharp down and then flat
38
What is the shape of P/L for writer of a short call?
Flat and then sharp down
39
What is the shape of P/L for writer of a short put?
Sharp up and then flat
40
What type of strategy is a long call? Max loss/gain and breakeven?
Bullish
Max Loss: Premium
Max Gain: unlimited
Breakeven: Strike + Premium
41
What type of strategy is a short call? Max loss/gain and breakeven?
Bearish / Neutral
Max Loss: Unlimited
Max Gain: Premium
Breakeven: Strike + Premium
42
What type of strategy is a long put? Max loss/gain and breakeven?
Bearish
Max Loss: Premium
Max Gain: Strike - Premium
Breakeven: Strike - Premium
43
What type of strategy is a short put? Max loss/gain and breakeven?
Bullish/ Neutral
Max Loss: Strike - Premium
Max Gain: Premium
Breakeven: Strike - Premium
44
How do you make a synthetic long call?
Long underlying + Long put
45
What is a highly geared option?
Smaller outlay, for a larger profit or loss e.g. OTM options
46
What is T Bill
UK Gov debt bond, usually up to 3 months. Zero coupon discount issuance
47
What is commercial paper?
Unsecured short dated company debt
48
What is a certificate of deposit?
Deposit with interest e.g. term deposit
49
Standard settlement for spot trades?
T + 2
50
How long can FX forwards be for?
Up to 12 months
51
What is the gilt edged market?
UK GOV Debt market
52
Life, coupon and settlement time for GILTS (UK)?
Up to 50 years
Semi annual
T+1
53
Life, coupon and settlement time for T bonds (US)?
T notes, 2-10
T bonds: Over 10
Semi annual
T+1
54
Life, coupon and settlement time for German Bonds?
Schatz: 1.75 - 2.25, Bobl: 4.5 - 5.5 Bund: 8.5 - 10
Annual
T+2
55
Life, coupon and settlement time for French bonds (OATS)
OATS - Up to 50
Annual
T+2
56
Life, coupon and settlement time for Italian bonds (BTP)
3 - 30
Semi Annual
T + 2
57
Life, coupon and settlement time for Japanese’s bonds (JGB)
Normal: 10, Superlong: 20
Semi annual
T+1 domestic
T+3 Cross border
58
For credit agencies what is a default rating?
Moody’s - C
S&P / Fitch - D
59
For credit agencies what is investment grade long term rating?
Moody’s: Aaa to Baa3
S&P and Fitch: AAA to BBB-
60
For credit agencies what is investment grade short term rating?
Moody’s: P1 - P3
S&P: A1 to A3
Fitch: F1+ to F3
61
What is the basic characteristics for equities?
Right to vote
Dividend
Right to surplus on winding up
62
What is a warrant?
Right to subscribe to new shares from a company at a fixed price on a future date
63
What is Gordon’s growth model?
Calculates share value based on discounting future dividends
64
What can impact supply and demand for agriculture?
Land / Weather / Tech / Gov / Transport
Wealth, Population, Taste/Trend
65
What is the main use and main source for Aluminium?
Aircraft, Packaging, Windows
US, Asia, Europe
66
What is the main use and main source for Copper?
Electronics / Buildings
Chile, US
67
What is the main use for Zinc?
Galvanised brass
68
What is the main use for Nickel?
Stainless steel
69
What is the main use for Lead?
Batteries, Added to Petrol
70
What is the main use for Tin?
Packaging
71
What is the main use for Gold?
Electronics, Jewellery, Investment
72
What is the main use for Silver?
Industry, Jewellery
73
Main use and sources for crude oil?
Fuel + Plastics
Brent, Dubai, West Texas
74
Main use and sources for natural gas?
Fuel + Manufacturing
Worldwide
75
Types of exotics?
Freight
Weather
Emissions
Crypto
76
Main products for derivatives?
Bonds
Commodities
Equities
Exoctics
FX
Interest rates
77
What is the tick size?
Minimum movement of a contract
78
What is the tick value?
Monetary value of one tick
79
What is ICE and how does it work?
Energy products, index, bonds and Interest
Electronic
ICE CLEAR
80
Who does the clearing for LSE?
LCH
81
What platform are trades done on for Euronext?
Optiq
82
How are trades cleared for Euronext?
LCH SA or Euro CCP
83
What is CBOT and how does it work?
Chicago Board of Trade, part of CME
open outcry and electronic
Agriculture, gold, interest
84
Who does CBOT have a joint trading agreement with?
SGX
85
What is CBOE?
Chicago Board Options Exchange
Largest US exchange trading
86
What is CME and how does it work?
Chicago Mercantile Exchange
Open outcry and electronic
Equities indices etc.
87
What does NYMEX trade?
Metal, Energy, oil
88
What is the role of an exchange?
Marketplace, ensuring a transparent market with reporting and published pricing
89
What is a principal trade?
Dealing for yourself (or firm)
90
What is an agency trade?
Firm isn’t taking a position but earns commission on the trade as a broker
91
What is a cross trade?
Broker can act for 2 clients with opposite matching trades
92
What is a general clearing member?
Clear for themselves, clients and non clearing members
93
What is an individual clearing member?
Clear for themselves and their clients
94
What is the order flow for open outcry system?
Order placement
Booth clerk (info carried across the floor)
Trade execution
Confirmation and matching
Registration
95
How are screen based orders usually ranked?
Price and then time
96
What is a market order?
At best order e.g. no price given
97
What is a limit order?
Specified volume, and no worse than price
98
What is a market if touched order?
Orders when price hits a certain point
99
What is an opening order?
Has to be executed during opening procedure
100
What is a closing order?
Closed during closing procedure
101
What is a limit or market on close order?
Standard order during the day, but closed out using best price if it reaches closing auction
102
What is stop order?
Close out the position if the market reaches a certain level
103
What is a good till cancelled order?
Order valid until expressly cancelled
104
What is Block trading facility?
Allows large deals to be agreed bilaterally on exchange (not at market price)
105
What is a basis trading facility?
Market users can enter into a conditional contract using a futures contract and cash instrument
106
What is an EFP?
Exchange futures for physical
107
how is fair value of a future calculated?
Spot price + cost of carry
108
Why would you do a cash and carry arbitrage?
Future is trading above fair value
109
Why would you do a reverse cash and carry arbitrage?
Future is trading below fair value
110
What is convergence for futures pricing?
Cost of carry reduces towards delivery date so futures prices trends towards the cash price
111
What is the arbitrage channel?
Theoretical arbitrage might be possible, but needs to be sufficient benefits to be economic in practise due to fees etc.
112
How is basis calculated?
Cash price - futures price
113
Why is basis usually negative?
Futures prices usually more than cash price as it includes the cost of carry
114
What is a contago market?
Negative basis, e.g. cash price less than futures price due to cost of carry
115
What is backwardation?
Positive basis, e.g. cash price more than futures price
116
Why might backwardation occur?
Temporary shortage of underlying
A Benefit to carry
117
If the basis strengths what does it do?
Narrow
118
If basis strengthens who gains / losses?
Short hedge - Gains
Long hedge - Loss
119
Is basis weakens who gains / losses?
Short hedge - Loss
Long hedge - Gain
120
How is cost of carry calculated for an equity?
Includes interest foregone minus the dividend yield
121
What is the beta?
Sensitivity of the stock to movement in price
122
What is a STIR?
Short term interest rate, CFD on interest
123
How does a STIR move in relation to interest rates?
Inversely to interest rates
124
If an investor thinks interest rates will increase should they buy or sell a STIR?
SELL
125
What is nominal value of a STIR?
£500k
126
How would you hedge a loan with a STIR?
Sell interest rate contracts (protects against rise in rate)
127
How is the premium on an option calculated?
Intrinsic value + Time Value
128
When is an option likely to be exercised?
When it is in the money
129
If there is lots of volatility how is the time value affects?
Higher time value due to the higher uncertainty
130
Who does the erosion of time act in favour of for an option?
Against the holder, as the asset is losing value each day
131
What does delta measure?
Sensitivity of the underlying
132
What does theta measure?
Time sensitivity
133
What does vega measure?
Volatility sensitivity
134
What does Rho measure?
Interest rate sensitivity
135
What is the impact on call / put premiums if delta increases
Call - Increases
Put - Decrease
136
What is the impact on call / put premiums if theta increases
Both increase
137
What is the impact on call / put premiums if vega increases
Both increase
138
What is the impact on call / put premiums if rho increases
Call - Increases
Put - Decreases
139
What is the impact on call / put premiums if dividends increases
Call - Decrease
put - Increase
140
What is the Black- Scholes methodology for premium?
Volatility + Time + price + exercise price + interest rate + dividends = premium
141
Alternative to black scholes model?
Binomial model
142
When is time value greatest?
When the option is at the money
143
How is delta calculated?
Change in value of premium / change in value of underlying
144
For ITM call options what is delta?
Long +1
Short -1
145
For ATM calls options what is delta?
Long +0.5
Short -0.5
146
For ITM put options what is delta
Long -1
Short +1
147
What is an options gamma?
How sensitive the delta is to a change in the underlying asset value
148
What does put call parity explain?
Relationship between premium of a call and put option on the same
Underlying asset, strike price and expiry
149
What is put call parity equation?
C - P = S * K/(1+R)^t
Call premium - Put Premium
Asset price * strike price / interest time
150
What is assignment of trades?
Placing trades in the appropriate account
151
What is allocation of trades?
Allocation is when traders under take trades on behalf of other firms. Executing broker gives up to the clearing broker
152
What is the key difference between a forward and future?
Forwards are OTC
153
What is a FRA?
Forward rate agreement
OTC interest rate future
154
If you are long a FRA what happens?
Pay a fixed rate and receive a variable rate, pays out if interest rates rise
155
If you are short a FRA what happens?
Receive a fixed rate and pay a variable rate, pays out if interest rates fall
156
What decimal point is a PIP quotes from
4th and 5th decimal
157
How do you know to add / takeaway for FX forward?
Forward rate will be a greater spread than the spot rate
158
What is the interest rate parity equation?
1 + r variable / 1 + r base
159
What is a currency swap possible for?
Fixed interest in one for floating in another
Fixed to fixed or floating to floating
160
What is an interest rate swap?
Agreement to swap payments on loans
161
How are payments paid out for an interest rate swap?
Netted payments
162
What is a basis swap?
Floating rate swapped for a different floating rate
163
Who is the payer on an interest rate swap?
The person who agreed to pay fixed - they are long the interest
164
How are cross currency swaps executed?
Notional principle changes hands and payments are not netted
165
What is a CAP?
OTC call option
166
What is a total return swap?
When investor makes payments linked to total return of a referenced asset without actually owning the asset
167
What is a synthetic equity fund?
Investor gains exposure to the equity without actually owning it
168
What is a CDS?
Credit default swap, insurance on an asset
169
When does the buyer of a CDS gain?
In a credit event e.g. significant fall in price, default event, gov intervention etc
170
What is a CLN?
Credit linked note allows the institution to protect from the default of the debtor by selling on the debt
171
The real time prices shared by the exchange usually show what?
Current prices best bid and ask
Last trade
Days high and low
Volume and open interest
172
Why do firms monitor open positions?
To prevent unwanted delivery situations
173
What does the ISDA do?
Bring together all OTC trades into one agreement
174
Main pieces agreed in an ISDA?
Termination Events
Default Events
Netting Off
175
What takes precedent the confirmation or ISDA
Confirmation
176
What is a CSA?
Register the criteria for collateral payments
177
What is master give up agreement?
Documents the relationship between dealer and prime broker
178
What is a deal ticket for OTC trades?
Effectively a trade report made after the trade is agreed
179
What is counterparty risk in derivatives?
Risk that once contract is agreed at least one party doesn’t meet the obligations
180
What is the clearing house guarantee principal to principal?
Guarantees its members obligations in relation to trades it clears for them
181
What is an independent clearing house guarantee?
Backed by clearing house resources
182
What is an mutual clearing house guarantee?
Backed by clearing house and its members
183
What is a Novation of a trade?
Clearing house becomes middle party between trades (sell / buy) counterparty
184
What is a position limit?
Set by some exchanges to stop one firm establishing a dominant position in the market
185
What are exchange price limits?
Limits to prevent the prices moving too far or fast in a trading session
186
What is initial margin?
Paid on contingent liability transactions, a returnable good faith deposit
187
What is SPan?
Calculation for initial margin - based on worst case scenario 1 day loss
188
What is intra day margin?
If market become volatile additional margin may be demanded at short notice
189
What is variation margin?
Accounts for prior days movements from open positions
190
When is VM paid?
Next business day (based on previous days movements)
191
How do holders of options pay VM?
No need to - premium paid up front
192
Does the writer of an option pay margin?
Yes they pay initial margin
193
When are premiums on options for futures typically paid?
Exercise or expiry
194
Do you pay VM on options on futures?
YES
195
What is TIMS?
Theoretical intermarket margining system
196
Names of IM / VM for OCC?
Risk margin and premium margin
197
What is a margin call?
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
What is the broker margin?
Margin brokers demand from their clients, got to be at least equal to clearing house margin
199
How are VM calls paid?
Cash
200
How are IMs typically paid
Lodging collateral with custodian, usually with a haircut and MTM
201
Types of acceptable collateral for UK clearing houses?
Cash, Bank Guarantee, UK debt (not EUR GILTS), EU debt and deposit certs (£ and $)
202
What is the threshold amount?
Max unsecured credit exposure taken
203
What is the minimum transfer amount?
Reduces cost by setting a minimum amount of collateral to be transferred
204
What is CSA?
Sets out rules / conditions for collateral to be transferred
205
What is collateral support docs?
Timings and procedures for MTM
206
What are the uncleared margin rules?
Principle based rules on non centrally cleared OTC derivatives
207
What is the threshold for UMR?
Aggregate average notional amount of uncleared contracts e.g. 8bn
208
What is principles based UMR?
Must exchange VM/IM
High quality collateral
Reg approved methodology
Segregation of assets
209
What is ISDA SIMM?
Approved method for calculating initial margin
210
3 options for holders of futures contracts
Close out
Roll forward
Proceed to delivery
211
What is EDSP?
Exchange delivery settlement price - price at which underlying changes hands on the delivery date
212
How are CFDs delivered?
Cash, difference between EDSP and previous days settlement price
213
What is the invoice amount?
Amount the long pays for the physically delivered asset
214
How is the invoice amount calculated?
EDSP x Number of Contracts x Contract size
215
Who send the exercise notice?
Broker to LCH once holder informs them of intention to exercise
216
Who send Assignment notice?
Clearing house randomly picks a writer to send an assignment notice to once they receive the exercise notice
217
What is automatic exercise?
Clearing house can turn on automatic exercise if desired to ensure ITM transactions are not forgotten
218
What is an inter market spread?
Buying correlated futures simultaneously on different assets with the same delivery dates
219
What is an intra market spread
Buying and selling the same future with different expiries to make a profit
220
What are intra market strategies?
Trade the spread
Reduce risk
Arbitrage
Roll over existing positions
221
What is a synthetic long?
Short put + Long call to get one straight upward line
222
What is a synthetic short?
Long put and short call to get one long downward line
223
How do you do a covered call?
Long underlying and a short call
224
What is the motivation for a covered short call?
Enhance returns in a stagnant market and partly hedge the long underlying position
225
Features of a covered call?
Downside protection
Return if share price is unmoved
Return if option exercised
226
What is the motivation for a covered short put?
Enhance returns in a stagnant market and partly hedge short position
227
How do you do a covered short put?
Short underlying and short buy position
228
What are derivative combinations?
Strategies with a call and a put
229
What is a long straddle shape?
Big V
230
What is strategy for a long straddle?
High volatility
231
Breakeven and max loss on a straddle?
Breakeven = Strike and premium
Max loss = both premiums
232
What is strategy for a short straddle?
Low volatility
233
Breakeven and max profit on a short straddle?
Breakeven = Strike and premium
Max profit = both premiums
234
Shape of a short straddle?
Arrow up
235
What is a strangle?
Like a straddle but both options have different strikes
236
Breakeven for strangle?
Strike +- both premiums
237
Strategy for a short strangle?
Low volatility, max profit is only both premiums
238
What is an option spread?
2 calls or 2 puts (must be the same!!)
239
What is a vertical option spread?
Taking advantage of different strikes between 2 calls (or 2 puts)
240
What is a horizontal spread option?
Taking advantage of difference between 2 calls (or 2 puts) across different expiries
241
What is a diagonal spread?
Taking advantage of different strikes between 2 calls (or 2 puts) across different expiries
242
What is a bull call vertical spread?
Long underlying with higher premium
Short call with lower premium
243
What is a bear call vertical spread?
Short underlying with higher premium
Long call with lower premium
244
Types of investors and their objectives for derivatives?
Retail - limited
HNW - not overly speculative
Corporate - Hedging
Asset managers - Hedging and speculation
Hedge Funds - speculative
245
What are the purpose of regulators?
Orderly markets
Consumer protection
Fight crime
Reduce systemic risk
246
What does MIFID do?
Harmonise rules governing EEA
Passporting
Set Capital Requirements Directive
247
What does MIFID II do?
Increased scope and increased protection
Emphasis on corp governance
More trading venues covered
248
What is the transparency directive?
Establishes minimum financial reporting requirements and disclosures for shareholders to be admitted on to EU regulated market
249
What is best execution?
Obligation to execute on terms most favourable to the client
250
What is client asset protection?
Segregate assets from firms own assets and reconcile as often as necessary
251
What is FINRA?
Financial Industry Regulatory Authority, regulates firms dealing in securities
252
Who regulates the US securities market?
SEC
253
Who regulates the US derivatives market?
CFTC
254
What is the NFA
National futures association, SRO that regulates firms dealing in the derivatives market
255
What is Part 30 of the commodities exchange act?
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
What is a Part 30 exemption?
Allows a Non US Firm to deal with US investors dealing on non US exchanges
257
How do US rules on asset segregation differ to UK?
All clients money in US must be segregated. In the UK, professional clients can opt out of segregation
258
How do the rules on 2 way consent differ between UK and US?
UK only retail clients need to sign a client agreement and risk warning
US all clients must sign these
259
What did the Dodd frank act do?
Mandatory electronic confirmations and central clearing
