Derivatives Flashcards
How to value a swap rate at Y days?
1) Fixed rate * (Y/360)
2) Calculate new fixed rate ( (1-z) / (x + y + z) )
3) NA * (# in 1 - # in 2) * (x + y + z)
How to value currency swap after Y days?
Amount in USD * (Fixed rate * (x + y + z) + z) - (Amount in CAD/new FX) * (CAD fixed rate * (x + y + z) + z)
How to value an equity swap?
NA * (Equity return - Floating rate)
What does 3 X 9 FRA mean?
To be received in 3 months based on 6 month rate
What is the hedge ratio formula?
h = (c+ - c-)/(s+ - s-)
What is delta?
Change in price of option given change in price of underlying
Delta for call is always positive
Delta for put is always negative
What is gamma?
Change in delta given small change in price of underlying
What is theta?
Change in value of option given small change in calendar time
Typically negative
What is vega?
Change in value of option given small change in volatility
Always positive
What is rho?
Change in value of option given small change in risk-free rate
Call: positive
Put: negative
What is a covered call?
Own asset Sell call (obligation to sell)
What is a protective put?
Own asset Long put (right to sell)
What is an option spread?
Investor buys one option and writes another of the same type
What is a bull spread?
Buy a call
Write a call with higher exercise price
What is a bear spread?
Buy a put
Write a put with lower exercise price
What is the max profit for a bear spread?
Strike of long put - strike of short put - net premium paid
What is a collar?
Own asset
Sell call
Buy put
What is a calendar spread?
Buy long-dated option
Write shorter-dated option
Objective: take advantage of faster time decay with shorter-term option
What is a straddle?
Investor buys put and call with the same exercise price
Hope for high volatility
What is a synthetic long?
Buy call + Sell put
What is a synthetic short?
Sell call + Buy put
What is a synthetic put?
Buy call + Short stock
What is a synthetic call?
Buy stock + Buy put
What are the motivations for entering into a covered call?
1) Income generation
2) Improving on the market
3) Target price realisation
What are the insurance policy comparison with put option?
Premium: Time value Value of asset: Price of stock Face value: Exercise price Term of policy: Time until expiration Likelihood of loss: Volatility of stock
What is the formula for π in binomial option?
(1+r-d)/(u-d)
What is the formula for call in binomial model?
c= PV(πc+ + (1-π)c-)
What is the formula for put in binomial model?
p = PV[πp+ + (1 – π)p–]
What are the assumptions of the BSM model?
Lognormal distribution of the return
Continuous prices
The underlying instrument is liquid, meaning that it can be easily bought and sold.
Continuous trading is available, meaning that in the strictest sense one must be able to trade at every instant.
Short selling of the underlying instrument with full use of the proceeds is permitted.
There are no market frictions, such as transaction costs, regulatory constraints, or taxes.
No-arbitrage opportunities are available in the marketplace.
The options are European-style, meaning that early exercise is not allowed.
The continuously compounded risk-free interest rate is known and constant; borrowing and lending is allowed at the risk-free rate.
The volatility of the return on the underlying is known and constant.
If the underlying instrument pays a yield, it is expressed as a continuous known and constant yield at an annualized rate.
What does being long in a FRA mean?
Long is floating receiver: gains when Libor rises
Short is fixed receiver: looses when Libor rises
A bond futures contract is most likely accompanied by:
Conversion factor; supposed to make all eligible bonds equal the same amount
Cheapest-to-deliver bond emerges after adjusting for the conversion factor.
What is the formula to calculate the futures value of a bond?
= ( (Value of bond)(1+i)^t - (Coupon)(1+i)^t) / Conversion factor
What is a cash and carry strategy?`
Buying the stock and selling the forward
What is a curve trade?
Trade designed to profit from changing expectations about a company’s credit quality.
What is a payer swaption?
Gives the owner an option to enter a swap as the fixed rate payer/floating rate receiver.
What is a receiver swaption?
Allows the holder to enter a pay floating swap (pay floating/receive fixed)
