Derivatives Flashcards
Derivative Markets: Derivatives
- A derivative security derives its value from the price of another (underlying) asset or an interest rate
- Futures and some options are traded on organized exhanges
- Forward contracts, swaps, and some options are custom instruments created by dealers
Derivative Markets: Forward Commitments and Contingent Claims
Derivative Markets: Forward Contracts
- Customized: No active secondary market
- Lond obligated to buy; short obligated to sell
- Specified asset (currency, stock, index, bond)
- Specified date in the future
- Long gains if asset price is above forward price
- Short gains if asset price is below forward price
Derivative Markets: Futures Contracts
- Like forward constract but standardized
- Exchange-traded, active secondary market
- Require margin deposit
- No defauly (counterparty) risk
Derivative Markets: Swaps
- Equivalent to a series of forward constracts
- Simple interest rate swap
- One party pays a fized rate of interest
- One party pays a variable (floating) rate of interest
- Payments can be based on interest rates or stock/portfolio/index returns
- Can involve 2 different currencies
Derivative Markets: Purpose and Criticism of Derivative
- Derivatives are criticized as being risky and likened to gambling
- Benefits of derivatives markets
- Provide price information
- Lower transaction costs
- Allow the transfer of risk
Derivative Markets: Role of Arbitrage
- Arbitrage is possible when two securities or portfolio have identical future payoffs but different marker prices
- Trading by arbitrageurs will continue until they affect supply and demand enough to bring asset price to efficient (no-arbitrage) levels
- Arbitrage relations are used to value derivatives
Forwards: Forward Contract Positions
Long position_ (will buy)_
The party to the forward constract that agreees to buy the underlying or physical asset
Short position_ (will sell)_
The party to the forward contract that agrees to sell/deliver the asset
Neither party pays at contract initiation
Forwards: Forward Contract Settlement
- Delivery: Short delivers underlying to long for payment of the forward price
- Cash settlement: Negative side of contract pays the positive side
Forwards: Early Termination of Forward
- One party pays the other cash (buys their way out)
- Enter into an offsetting contract
- With a different coutnerparty (Default risk still exists)
- With same (origianl) counterparty (no default risk)
Forwards: Dealers and End Users of Forwards
- A dealer creates a derivative contract and will quote a price to take a long or short position
- An end user is typically a corporation or institution seeking to transfer an existing risk
Forwards: Equity Forward Contracts
Forwards: Equity Index Forward - Problem
Forwards: Forward on Zero-Coupon Bonds - Example
Forwards: LIBOR-Based Loan Example
Forwards: FRA
Forward Rate Agreement (FRA)
Exchange fixed-rate for floating-rate payment
- Notional amount
- Fixed rate = forward (contract) rate
- Floating rate (LIBOR) is underlying rate
- Long gains when LIBOR > contract rate
Long position can be viewed as the obligation to take a (hypothetical) loan at the contract rate(i.e. borrow at the fized rate); gains when reference rate increases
Short position can be views as the obligation to make a (hypothetical) loan at the contract rate (i.e. lend at the contract rate; gains when reference rate decreases
Forwards: FRA - Example
Forwards: FRA Settlement Payment to Long
Forwards: Currency Forward Contracts
- Currency forward contracts are committment to buy or sell a certain amount of a foreign currency for a fixed amount of another currency in the future
- As with other forwards, cash settlements is the amount necessary to compensate the party who would be disadvantaged by the actual change in market rate as of the settlement date
Futures: Chacteristics
Futures: Forwards vs. Futures
Futures: Margin Terms
Futures: Trade - Example
Futures: Price Limits
Futures: Marking-to-Market
Futures: Margin Calculation Example
Futures: Methods to Terminate a Futures Position at Expiration
Futures: Closing a Futures Trade by Offset
Futures: Contract Delivery Options
Futures: Eurodollar Futures
Futures: Treasury Bond Futures
Futures: Stock Index Futures
Futures: Currency Futures
Options: Basics
Options: Terminology
Options: Moneyness
Options: Call Option - Example
Options: Put Option - Example
Options: Exchange-Traded vs. OTC Options
Options: Underlying Assets
Options: Interest Rate Options
Options: Two Interest Rate Option = One FRA - Graph
Options: Interest Rate Caps and Floors
Options: Cap and Floor Payoffs
Options: Interest Rate Option - Problem
.
Options: Value
Options: Notation
Options: Minimum and Maximum Values
Options: Differ by Exercise Price
Options: Deriving Put-Call Parity (European Options)
Options: Parity Conditions and Synthetic Options
Options: Put-Call Parity - Problem
Options: Time, Volatility, RFR, and Stock Price
Options: Cash Flows on the Underlying Asset
Swaps: Overview
Swaps: Characteristics
Swaps: Terminology
Swaps: Termination
Swaps: Currency Swaps - Example
Swaps: Plain Vanilla Interest Rate Swap
Swaps: Plain Vanilla Interest Rate Swap - Formula
Swaps: Fixed-for-Floating Swap Example
Swaps: Equity Swaps
Swaps: Equity Swaps - Example
Swaps: Equity Swaps - Problem
Risk Management: Call Intrinsic Value/Payoff at Expiration
Risk Management: Profit and Loss: Call Options
Risk Management: Put Intrinsic Value/Payoff at Expiration
Risk Management: Profit and Loss: Put Options
Risk Management: Call Profit and Loss - Problem
Risk Management: Covered Call Strategy
Risk Management: Covered Call - Problem
Risk Management: Payoffs and Profits - Covered Call
Risk Management: Protective Put Strategy (Position)
Risk Management: Protective Put - Example
Risk Management: Profit and Payoff - Protective Put
