Derivatives Flashcards
What is derivative?
It is security that derives its value from an underlying asset
What happens when spot price=forward price?
No party has profit
What happens when spot price>forward price?
Buyer has profit, seller has loss
What happens when spot price<forward price?
Seller has profit, buyer has loss
What is derivable contract?
Payment and shares are exchanged
What is cash-settled contract?
Only gains/losses are exchanged
What is central clearhouse?
It is party that takes opposite position to each side of trade guaranteering the payments promised under the contract, requires deposits from each party
What is central clearing mandate?
It is used for swap trades, a central counterparty takes credit risk of both sides
Where swap trades trade?
In dealer market, where margin deposits and MtM payments may be required
What is credit default swaps?
It is when buyers makes fixed paymens on settlement date and seller pays only if underlying asset has a credit event
What is option premium?
It is price of an option
What is payoff of call option to the owner?
Max(0, S-X), benefits when S>X
What is payoff of put option to the owner?
Max (0, X-S), benefits when X>S
What is maximum loss for the buyer of an option?
Its premium
What is loss for the writter of an option?
Unlimited
What is forward commitment?
It is legally binding promise to perform some actions in the future
What is contingent claim?
It is claim that is dependent on particular event
What is hedge accounting?
It is recognition of gains/losses of qualifying derivative hedges at the same time they recognise changes in values of assets and liabilities being hedged
What are considered cash flow hedge?
It is floating to fixed rate liability, exchange rate value hedge
What are considered fair value hedge?
It reduces changes in the value of firms assets/liabilities
What is net investment hedge?
It reduces volatility of equity in value on the BS
What is two portfolio theory?
Two portofolios with the same payoff in the future for any future value will have the same cost today
What strategy should be employed when forward price is too high?
Sell forwards and buy the underlying asset
What strategy should be employed when forward price is too low?
Buy forwards and sell underlying asset
What is replication?
It is creating a portfolio with cash market transactions that has the same payoffs as a derivative for all possible future values of the underlying
Formula of no-arbitrage forward price
S0(1+Rf)^t
Formula of no-arbitrage forward price with costs and benefits
Formula of value of forward contract to the buyer with benefits and costs
St+PV(costs)-PV(benefits)-F0(T)(1+Rf)^-(T-t)
What is implied forward rate?
It is forward rate for which two strategies have the same yield over the total period: lending for the whole period or dividing lending into separate period
Formula of interest rate future prices
100-(100*MRR)
What is basis point value of interest rate futures contracts?
It is one basis point change on futures contract value
Formula of basis point value of interest rate futures contract
notional principleperiod0.01%
Are futures marked-to-market daily?
Yes
What is attractiveness relationship with futures and interest rates?
They are more attractive when positevely correlated
What is interest rate swap equivalent to?
It is equivalent to a series of forward contracts each with a forward contract rate equal to fixed swap rate
What is par swap rate?
It is fixed swap rate that gives zero value at initiation
What is swap equivalence formula?
MRR/1+S=F/1+S
What is considered in the money?
When immediate exercise of an option creates positive payoff
What is considered out of money?
When immediate exercise would create a loss
When are options in the money?
Call: S-X>0, put: X-S>0
When options are out of money?
Call: S-X<0, put: X-S<0
What is time value of an option?
It is amount by which option premium exceeds the exercise value
Formula of option premium
exercise value+time value
What is upper bound for call options?
c<=St
What is upper bound for put options?
pt<=X(1+rf)^-(T-t)
What is lower bound of call option?
c0>=Max[0 ; S0-X(1+rf)^-T
What is lower bound of put option?
p0>=Max[0 ; X(1+rf)^-T-S0]
What is fiduciary call?
It is combination of call with exercise price X and pure discount bond that pays X at maturity
What is payoff of protective call when in/out of money?
X when out of money, S when in the money
What is protective put?
It is share of stock and put of stock
What is payoff of fiduciary put when in/out of money?
X when in the money, S when out of money
Formula of put-call parity relationship
c+X(1+rf)^-T=S+p
What is put-call forward parity
Derived with forward contracts rather than underlying asset
Formula of put-call forward parity
c+X(1+Rf)^-T=F(T)(1+Rf)^-T+p
