Derivatives Flashcards
When does either party make payment on a futures contract?
At the delivery date
What does the buyer and seller hope happens to the market price of the underlying asset in a futures contract?
Buyer - hopes price rises
Seller - hopes price falls
What’s the difference between a cash settled and physical delivery future?
Physical delivery - seller delivers set quantity of good on delivery date
Cash-settled - set amount of money exchanged per contract
What obligations do the buyer and seller have on delivery date of a future?
Both have obligation to deliver or take delivery
What is the main risk of a futures contract?
If either party can’t fulfil their obligation
What is the main difference between a future and a forward?
Forwards are traded OTC, whereas futures are exchange-traded.
Is an option exchange-traded, OTC or both?
Both
State the difference between a call and a put option.
Call - buyer has right to buy the underlying asset
Put - buyer has the right to sell the underlying asset
What is the most an option holder can lose?
The upfront premium
State the difference between European and American style options.
European style - can only be exercised at expiry
American style - can be exercised at any time up to expiry
When would a call option be ‘in the money’?
When the underlying market price is more than the strike price
What does Delta measure?
How option price changes as the underlying’s price changes
What does Gamma measure?
The rate of change of delta
What does Vega measure?
How the option price changes for a 1% change in implied volatility.
What does Theta measure?
The change in an option’s price due to the passage of time.
Name the two different types of warrants.
Traditional
Covered
Describe how a traditional warrant works.
-Gives investor right to buy shares at a set price on pre-determined dates
-Price is fraction of the share’s price
-Movements in the warrant’s price magnify changes in the underlying share price.
What does the conversion ratio show?
How many warrants equal one share
If the warrant price = 150p, the exercise price = 170p and the ordinary share price = 750p, what is the conversion premium/discount?
[(150+170)/750]-1= -57.33%
If the share price is 175p, gearing is 8 and the investment amount is £12,600, how many shares/warrants can be bought?
7,200 shares or 57,600 warrants
What is the initial margin on a contract for difference?
Amount deposited at outset by buyer and seller which acts as collateral
How much margin has to be put up if:
12,000 CFDs bought
£1.70 share price
15% margin
12,000 x 1.7 x 0.15 = £3,060
What is the profit if:
£20,000 to invest in CFDs
Margin is 12.5%
Share price rises from £2 to £2.75
£20,000 / 0.125 = £160,000 worth of shares
Which is £160,000 / 2 = 80,000 shares
Profit = 80,000 x (2.75-2) = £60,000
State the benefits and drawbacks of contracts for difference.
Benefits:
-Magnified gains
-No Stamp Duty/SDRT
-Can go long or short
Drawbacks:
-Magnified losses
-CGT on gains
-Broker commission due
What does a higher credit spread indicate about a third party?
Higher credit risk
What are the two potential outcomes in binary betting?
Nothing
OR
Fixed Amount
