Derivatives Flashcards

1
Q

Futures

A

Exchange traded forward contract

Legally binding agreement to buy/sell asset at specified future date at price agreed when contract is made

Buyers take long position -expect prices to rise

Sellers take short position - expect prices to fall

The long futures position makes money in a rising market and loses money in a falling market

The short futures position hopes to make money in a falling market and loses money in a rising market

Initial margin acts as collateral

Marking to market - revalued on daily basis

Position closes when contract reaches expiry or investor ‘closes out’ position

Can be used to hedge portfolios against adverse market conditions

When the futures price is higher than the price of the underlying asset - market is in Contango.

When the futures price is lower than the price of the underlying asset, the market is-in backwardation.

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2
Q

Options

A

Gives buyer right but not obligation to
buy/sell specific asset at fixed price before or on a certain date

Call option - right to buy

Put option - right to sell

Buyer of a call option takes a long call
position - the more the price rises the more profit the buyer will make

Buyer of a put option takes a long-put
position - the more the price of the
underlying asset falls the greater the profit for the buyer

Margin payments - made by seller only

Choices are: exercise/sell/expire

Intrinsic value (value of the option)

In-the-money - strike price is below current price of asset

Out-of-the-money - strike price is above current price of asset

At-the-money - strike price is the same as the current price of asset

The more time an option has luntil expiry the greater the chance it will end up in-the- money (so higher premium)

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3
Q

Hedging advantages

A

Lower dealing costs than trading underlying physical assets

Speed of dealing

Liquidity

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4
Q

Traditional warrants

A

Traditional warrants

Long-term call option issued by companies

Holder has right but no obligation to buy shares at fixed price and date

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5
Q

Covered warrants

A

Type of option issued by financial institutions such as investment banks- traded on LSE
O
‘Covered’ because investment bank (the writer) covers or hedges its exposure by either
buying the underlying stock or takes out futures or options on an exchange

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6
Q

Specialised collectives

A

Futures and options funds (FFs), geared futures and options funds (GFOFs), capital
protected unit trusts and OEICs

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7
Q

Contracts for difference

A

Contracts for difference
O
Geared investment used for trading shares (long or short)
C
Geared so only proportion of the value of a trade is needed to fund a trade
O
Used by stock market traders

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8
Q

Spread and binary betting

A

Placing bets with a spread betting firm

Trading is done on a margin

Pure speculation

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9
Q

Hedge funds

A

Pooled investments

Hedge Fund Association recognise 14 different investment strategies offering different risk/return

Most hedge funds aim to limit downside volatility

Gearing used by some hedge funds (adds to risk)

Usually limited partnerships or offshore funds

High minimum investment

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10
Q

Hedge fund strategies

A

Long/short funds - equity and/or fixed interest

Relative value funds - no market related element in returns

Event driven funds - use price movements from anticipated corporate events to achieve returns

Tactical trading funds - trade in currencies, bonds, commodities, equities (in each asset class they
may use the same long/short approach as equity hedge funds)
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11
Q

Hedge fund advantages and disadvantages

A

Advantages

Diversification
Low volatility strategy
Expertise of fund manager

Disadvantages

Lack of regulation/protection
High minimum investment
Complex
Volatile

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12
Q

Structure of structured products

A

100% capital protection
Partial capital protection
No protection

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