Derivatives

Question 1

Interest rate swaps are:

Answer 1

equivalent to a series of forward contracts.

A swap is an agreement to buy or sell an underlying asset periodically over the life of the swap contract. It is equivalent to a series of forward contracts. (Module 56.2, LOS 56.c)

Question 2

Arbitrage prevents:

Answer 2

prevents two assets of the same parameters from being sold at different prices.

Arbitrage forces TWO ASSETS with the same expected future value to sell for the same current price. If this were not the case, you could simultaneously buy the cheaper asset and sell the more expensive one for a guaranteed riskless profit. (Module 56.2, LOS 56.e)

Question 3

Derivatives pricing models use the risk-free rate to discount future cash flows because these models:

Answer 3

are based on portfolios with certain payoffs.

Derivatives pricing models use the risk-free rate to discount future cash flows (risk-neutral pricing) because they are based on constructing arbitrage relationships that are theoretically riskless. (Module 56.2, LOS 57.a)

Question 4

The underlying asset of a derivative is most likely to have a convenience yield when the asset:

Answer 4

must be stored and insured.

Think about holding a painting that becomes more rare in value, thus driving up its price on the market.

If something must be stored, and insured, it is likely that it has greater value, thus a convenience fee. (NOT CORN THO LOL)