Derivatives Flashcards
Where did derivatives originate from?
Agricultural markets.
What was the first derivatives exchange?
Chicago Board of Trade.
What does CBOT stand for?
Chicago Board of Trade.
What is a derivative?
A financial instrument whose price is based on the price of another asset (an “underlying”).
What are the types of assets that are the underlying in a derivative?
Bonds, shares or commodities such as gold, silver, corn and what.
What are the 4 uses of derivatives?
Hedging, anticipating future cash flows, asset allocation charges and arbitrage.
What are the 4 types of derivatives?
Futures, forwards, options and swaps.
Why would a derivative be used to anticipate future cash flows?
If there is a large inflow of cash expected then futures can be used to fix the price.
How can derivatives be used for hedging?
By buying/selling future contracts, buying put options or selling call options.
What is arbitrage?
When an investment manager tries to derive a risk free profit from buying and selling at the same time on different markets.
Can derivative futures be traded?
Yes.
What is a future derivative?
Where the price of an asset can be traded in the future at a price agreed today.
What type of agreement is a future derivative?
A legally binding agreement.
Where are futures traded?
On exchanges.
Name 2 derivative exchanges.
ICE Europe and the Chicago Mercantile Exchange.
On what terms are futures traded?
Standardized terms eg. only the price is open to negotiation.
What does standardized terms mean?
Only the price is open to negotiation.
What does go long mean when trading futures?
The position taken by the buyer who is committed to buying the underlying asset.
What does go short mean when trading futures?
The position taken by the seller who is committed to delivering the asset.
What is the opening of a future?
The initial trade.
What does it mean when a future is closed out?
That the assets are not delivered.
What does opening a long position mean?
Buying a future.
What does opening a short position mean?
Selling a future.
What does ICE stand for ?
Intercontinental Exchange.
What is an option derivative?
An option gives the buyer the right to buy and sell a pre-specified amount of an asset at a pre-agreed exercise price.
What does the seller of an option derivative get?
A premium.
What is the difference between an option and a future?
A future is a legally binding document.
What terms are derivative options traded on?
Standardized.
Where are derivative options traded?
On exchanges and OTC markets.
What is a derivative call option?
Where the buyer has the right to buy the asset at the exercise price and the seller is obliged to deliver.
What is a derivative put option?
Where the buyer has the right to sell the option and the seller is obliged to take the delivery and pay.
What are the owners of derivative options called?
The holders.
What are the sellers of derivative options called?
The writers.
When and who pays the premium on a derivative option?
The buyer at the start of the contract.
What is a naked position with derivative options?
When the writer does not hold the underlying asset.
What is a covered position with derivative options?
When the writer does hold the underlying asset.
What is a derivative swap?
An agreement to exchange on set of cash flows for another.
Where are derivative swaps traded?
OTC market.
What are interest rates swaps?
Where interest payments are exchanged with one usually being fixed and the other variable.
What is the purpose of an interest rate swap?
To hedge exposure to interest rate charges.
What are the two exchanges of the cash flow known as in a derivative swap?
The legs.
What does LIBOR stand for?
London Inter Bank Offered Rate.
What is a credit default swap?
Where one party buys credit protection from another party to which they make payments and in return receive compensation if the credit event ever occurs.
What are some types of credit events?
Defaulting, bankruptcy, a restructuring or a fall in the value of assets.
What is the purpose of a credit default swap?
To protect companies from unwanted credit exposure, or to increase exposure in return for income.
What are required when trading derivatives on an exchange?
An intermediary to be appointed and margins to be posted.
What is the main US derivative exchange?
The CME Group.
Where does the ICE operate?
US, Canada, Europe and Singapore.
What does the LME stand for?
The London Metal Exchange.
What is the German derivative exchange?
Eurex.
What are the main advantages of derivatives?
Removes uncertainty and risk of a lack of supply, allows hedging and offers speculation
What are the risks of derivatives?
An investor can lose more at the initial outlay and the potential losses are unlimited, market volatility and risk of counter parties defaulting.
