Derivatives and Risk Management Flashcards
SPOT PRICE
Current price in the marketplace at which a given asset can be bought/sold for immediate delivery.
RISK POSITION
Profit or loss that can be made on any position because of the price movement of an underlying (stock, bonds, FX).
2 POSSIBILITIES TO HAVE NO RISK IN 1 YR.
- Sell the Asset
2. Hedge the position by selling a derivative that has opposite P&L of the asset.
HEDGE
An investment that is made with the intention of reducing risk of the adverse price movements of an underlying.
DERIVATIVE
Security (financial contract) with price dependent upon or derived from one or more underlying assets.
FUTURES
Derivative of financial contract that obligates parties to transact an asset on a predetermined future date and price.
OPTIONS
Contracts that give the Option buyer (holder) the right, but not the obligation, to buy/sell a given amount of FX at a fixed price per unit over a specified period of time (maturity).
CALL OPTION
An Option to buy the underlying asset.
PUT OPTION
The Option to sell the underlying asset.
EXERCISE/STRIKE PRICE
Price at which the underlying asset can be bought (call) or sold (put)
PREMIUM
The cost/price/value of the Option.
THREE PRICE ELEMENTS OF OPTIONS
- Exercise/Strike Price
- Premium
- Underlying/Actual Price of an Asset in the market.
COUNTERPARTY RISK
In FX Options, it is the risk that one of the parties involved in the transaction might default on their contractual obligations.
HOLDER OF FX OPTION
Only exercises the right if the Option is profitable.
In Call Option, as spot price increases, holder has possibility of unlimited profit.
WRITER OF A CALL
Max profit is limited to the premium.
What the holder loses, the writer gains.
