Derivatives Flashcards

Question

What are the measure imposed on exchanges to protect both parties?

Answer 1

Exchanges impose; - Margin requirements - Position limits - Daily marking to market

Answer 2

Buyers/Sellers of Futures contracts must post Initial Margin, usually about 1-5% of the face value of the contract. Losses are deducted from investors' margin accounts. If future prices move against them, they will be asked to top up their margin to its original level. This is also known as the margin call).

Answer 3

This system is put in place to make sure that investors cannot walk away from a deal if prices move against them. By contrast, on a Forwards contract, no cash is paid or received until contract maturity.

Answer 4

- Forwards consist of private contract between 2 parties, whereas a simple Exchange is traded in Futures. - Forwards are non-standardised, while Futures are standardised - Forwards usually have 1 specified delivery date, while futures have a range of delivery dates. - A Forward is settled at the end of a contract, while Futures are settled daily. - While Forwards may have credit risk, Futures have no credit risk. 5, CSDSeR Contract Standardisation Delivery Settlement Risk

Answer 5

An Option is a derivative instrument that provides the holder (long position) with the right, but not the obligation, to complete a transaction on the underlying asset at a specific price (STRIKE PRICE) during or at a specific period of time (EXPIRATION DATE). If holder of Option chooses to exercise his right, the writer (Short position) is obliged to act on it.

Answer 6

This gives the holder the right (not obligation) to purchase the underlying security at the agreed strike price. For this right he/she pays the writer an up-front fee known as the 'Call Premium'. BUY

Answer 7

This gives the holder the right (not obligation) to sell the underlying security at the agreed strike price. For this right, he/she pays the writer an up-front fee known as the 'Put Premium' SELL

Answer 8

- Long Call _/ - Long Put \_ (For Holders) These are positions that investors will take to protect themselves from price fluctuation. Assuming similarity to Forwards, Buyers would tend to buy Calls and Sellers would tend to buy Puts. - Short Call -\ - Short Put /- (For Writers) The Horizontal area represents profit from premiums

Answer 9

They give you an Option === Draw Long/Short on eBay (Option price $5, Strike price $100, Option life: 2 months) Draw Long/Short on IBM (Option price $7, Strike price $70, Option life: ???)

Answer 10

If they are the 'Writer' of the Option.

Answer 11

The Black-Scholes Option pricing model is used to calculate the value of standard (vanilla) options based on certain assumptions: in particular about future volatility of the underlying asset. Increased volatility makes options more valuable. 'Exotic' options may need more complex valuation models.

Answer 12

A Swap is an agreement between 2 parties to exchange assets and/or a series of Cash flows in the future. Can also be thought of as a series of individual forward agreements stretching into the future.

Answer 13

They are typically used for hedging rather than speculation. They are generally used to hedge interest rate (fixed vs. floating) and foreign exchange exposures.

Answer 14

Swaps are OTC derivatives, and are highly customised to users' needs. Many different types exist, including Credit-Default Swaps.

Answer 15

Derivatives allow firms to hedge their risks cheaply and efficiently. They are also a very effective tool for speculation.

Answer 16

The high gearing and complexity of some derivatives, sometimes coupled with outright fraud, has led to some massive losses. Nick Leeson is just one example. They are a powerful tool if used correctly, but dangerous if used badly.