Derivatives and other instruments Flashcards
future long positions and short positions make money
rising market
falling market
fair value of future
cash price of underlying asset bought today + costs of carry
costs of carry
interest rates
storage
insurance
basis
cash price - futures price
contango
basis is negative
> cash price < futures price
backwardation
basis is positive
> cash prcies > future price
temporary shortage of supply
benefit of carry - divided yield on equity or equity index higher than interest rate
forward and futures differences
forward:
traded on OTC
more flexible
counter party risk
no central market place (tough to value the contract and price it)
futures:
traded on exchange
contracts are standardised
roll contract used by fund managers (commodity contracts)
manager does not wwant to proceed to making or taking delivery and they
close out the current contract
open a position in longer-dated
differences between options and futures
option:
seller of option has a potential obligation, buyer has choice
buyer of option pays premium
futures (on exchange):
both parties have the obligation
no premium paid
premium =
intrinsic value (profit neglecting costs) + time value
delta =
change in the price of the option premium / change in the price of underlying
delta for calls and puts
positive for calls (0 to1)
negative for puts (-1 to 0)
time value influencing factors (amount over and above the intrinsic value that an investor will pay for an option)
> volatility of underlying asset (vega) - more volatile higher time value
interest rates (rho) - call r incr. time value inc. / put r incr. time value decr.
remaining life of option (theta) - more time higher time value. less time time value decays faster
protective put
holding the asset and buying puts to hedge a position
number of otpions to buy to hedge
value of portfolio / value of index option * beta
covered call
short OTM call option + long position
> in static market
> yield enhancement strategy
protective put
long position + long put option
> hedge against a falling market
long straddle
increase in volatility
long in call and put with same strike
long strangle and short strangle
increase in volatility
decrease in volatility
OTM option
interest rate swaps
principal amount notional
agreements to swap cash flow
payments can be netted (have same currency)
compounded fixed rate and the other is variable TSRR
currency swap
no netting
notional principal exchanges hand in the beginning
credit default swap for an index
pay premium
firms receive proportional compensation
continues even after default event
first loss ( full payment on first loss)or tranche loss
constant maturity default swaps
premiums are variable
risk of failure increases hen higher premium
synthetic CDO
no physical transfer of bonds or loans
CDO gains exposure by selling CDS to credit institution
receives cash
wider variety of loans become accessible because of no physical transfer
credit linked notes
funded credit derivative
linked to debtors or pool of debtors
price depends on risk debtor
coupons linked to interest payed and redemtpion value
issuer not obligated to pay coupons or repay debt if a specified event occurs
unfunded credit derivative
b/een 2 parties
make payments
settlement no recourse to other assets
funded credit derivative
protection seller makes initial payment used to settle potential credit events
ETC
open ended companies
gain exposure to commodities through derivatives
fund mngrs roll on their positions
don’t exactly mimic commodity values
precious metals and base metals perfrom better when
economy is in uncertainty
economy is expanding
where do they trade
softs and agricultural
metals
energy products
exotics (weather and emissions)
UK ICE Futures europe
uk london metals exchange
uk intercontiental exchange us new york mercentalie exchange
chicago mercentile exchange
commodity derivative indices
S&P GSCI
BCOM
RICI
TR/J CRB
S&P GSCI
components:
liquidity
weighted by global production levels
24 commodities
60% energy
15% agricultural
11% base metals
livestock + precious metal
BCOM
liquidity
dollar adjusted production levels avg over 5 yrs
15% individual commodites
33% sectors
RICI
38 commodities from 9 international exchanges in 4 countries
commodities for inclusion decided by RICI committee
used if play role in consumption for developed and developing countries
diverse
TR/J CRB
commodity futures price index
19 commodities quited on NYMEX, CBOT, LME, CME and COMEX
4 groups of liquidity with different weights
contract siZe for the FTSE 100
£5 per half index point
delivery dates : March, June, September, December
theta
measures the sensitivity of an option premium relative to change in the remaining life of the option
option is at the money
made up of time value alone and time value is high because of increase d uncertainty
number of option to buy to hedge
(value of portfolio/value of index option )* beta
cheapest to deliver
> notional bond
short chooses bond from list of DELIVERABLE BONDS
contract physically delivered
ICE Futures Europes STIR
traded on ICE
bet on the interest paid on £500k deposit
> 3 month term starting at a futur date
> speculation or hedging
> settle for cash
> tick size 1 bp
tick value: 12.50
swap market
> financial organisations and money market institutions
OTC
series of transactions at set intervals for a fixed period in the future
CFD exchange of cashflows at the end of each interval
equity swap
> avoid costs
equity leg (gains/losses and dividends)
interest leg (LIBOR) – deposit
types of commodity
softs and agricultural (ICE Futures europe)
metals precious in economic uncertainty, base when economy is expanding) (Londons metal exchange)
energy products (Intercontinental exchange UK , US New york mercantile exchange)
exotics (weather (Chicago Mercantile Exchage) and emission
LCH.Clearnet
> independent
owned by member firms
clearing process for 3 London derviative exchanges
long gilt future ( ICE Futures Europe)
profit/loss = number of ticks moved * tick value * number of contracts traded
tick: 0.01BP
tick value = 10
bond futures key facts
> based on notional gilt
gilt delivered is form basket of deliverables
exchange chooses basket
short chooses gilt to deliver form basket
gilt is the cheapest
ICE Futures Europe’s FTSE 100 future
> cash settled
contract quotation: £10 per point 1
delivery dates: March june september december
