Derivatives Flashcards
Derivative
financial instrument that ~derives~ it’s value from the performance of an underlying asset (equities, fixed income, currency, commodities); always a winner and a loser
Underlying Asset
value with risk whose performance determines the value of the derivative (equities, fixed income, commodities, currency)
Long
buyer of the derivative; holds the long position
Short
seller of the derivative; holds the short position
Forward Commitment
type of derivative; forces 2 parties to interact in the future at a price previously agreed upon
Option/Contingent Claim
right but NOT the obligation to transact in the future at a previously agreed upon price
Risk mangement
process that an organization defines the level or risk it wishes to take and measures the level of risk it’s taking, then adjusts; doesn’t get rid of risk
Exchange Traded Commodities
matches sellers and buyers; rules/regulations; NYSE
OTC Securities Markets
rules and regulations; bring sellers and buyers together in a physical location; not standardized, less regulated
Clearing
process where exchange verifies execution of transactions and records them
Settlement
exchange transferred money is transferred from one party to another
Credit Guarantee
if the loser of a derivative trade can’t pay the clearing house will pay
Margin/Performance Bond
cash deposit required by the clearing house for the contract participants
Transparency
full information of all transactions is disclosed to exchanges and clearing houses; exchange markets trait
International Swaps and Derivatives Association (ISDA)
worldwide organization of financial institutions that engage in derivative transactions (mostly as dealers)
“Lay Off”
get rid of
Dealer Markets
dealers informally agree to buy/sell various derivatives
Forward Commitments
~have~ to transact at the expiration date
Fixed Price
forward price; price at which the underlying will be exchanged
Forward Contract
OTC contract at a fixed date and price
Non-Deliverable Forwards/Cash-Settled Forwards/ Contracts for Differences
cash is exchanged at the end of the contract ~not~ the underlying asset; cash given gives the long enough money to buy the underlying at market value
Futures
standardized forward contracts that trade on futures exchanges
Characteristic of Future Exchanges
highly regulated; specific underlying assets, expirations, settlement instructions, quantities
Futures Price
agreed upon price of the future exhange
Mark to Market
daily settlements; aggregate average of identical future trades that is then the settlement price
Margin Account
both long and short deposit money into the account to cover losses if one can’t deliver; ex: short can’t deliver, the long is paid out of the margin account
Maintenance Margins
amount of money each party needs to retain in the margin account after the trade is initiated
Margin Call
if one party’s loss is so great their margin account < maintenance margin they have to deposit enough to cover the initial margin account (not just the maintenance margin)
Price Limit
limit based on band relative to the previous day’s settlement price
Limit Up
trading stops b/c one party wants to trade above the price limit until the parties agree to a price lower than the price limit
Lower Limit
trading stops because one party wants to trade at a price below price limit; starts when they agree on a price above the lower limit
Locked Limit
when market hits the limits and trading stops
Call
right to buy
Put
right to sell
American
can be called/put at any time before the expiration date
European
can only be called/put on expiration date
Exercise/Strike Price
fixed price where underlying can be sold/bought
Option Premium
fair price of the option in a well functioning market
Well-Functioning Market
transparent information and free trade
“In the Money”
underlying value > exercise price
“Out of the Money”
underlying value < exercise prices
Payoff Amount
value of option at expiration
“At the Money”
underlying value = exercise price
Credit Derivatives
contract between 2 parties with a credit protector buyer and a credit protection seller
Total Return Swap
buyer pays the seller the TR (principal and interest payments) of the underlying and the seller pays the buyer a fixed or floating rate of interest; if there’s a default on the underlying the seller doesn’t get the interest payments but still has to pay buyer the interest
Credit Spread Option
underlying is a credit (yield) spread; buyer chooses strike price and pays premium to seller; if option is in the money seller pays buyer established pay off
Yield Spread
difference between the bond’s yield and the yield on a benchmark default-free bond; shows prediction of risk
Credit-Linked Note (CLN)
buyer holds default risk on the underlying and issues a new security (CLN); if the underlying defaults the payoff on the CLN is also reduced; CLN insures credit risk of underlying
Credit Default Swap CDS
protection buyer makes regular payments to seller, seller doesn’t make any payments until a credit event occurs
