Derivatives Basics

Question 1

Main differences between futures and forwards?

Answer 1

Forwards: negotiated, OTC, customisable, default risk, physical delivery, settled on maturity

Futures: Standardised, centralised through an exchange, counterparty risk, cash settled, settled daily.

Both can be either cash settled or delivered.

Question 2

What do we call the price paid or recieved for the purchase or sale of an option?

Answer 2

Premium

Question 3

True or False?
A buyer is long,
a seller is short

Answer 3

True

Question 4

What are the main reasons for participation in derivative markets?

Answer 4

Hedging, Speculating, Arbitrage

Question 5

Which single option would I purchase to hedge from extreme downside risk?

Long call, short call, long put, short put

Answer 5

Long put

Specifically an OTM (out the money) put

Question 6

Define Arbitrageurs

Answer 6

Will use differences in “risk perception” in different markets to buy/sell securities in those markets to “lock in” a riskless profit.

Question 7

Cash required by an exchange to settle daily losses

Answer 7

Margin

Gains or losses made on futures contracts are marked to market daily.

Question 8

Define OTC

Answer 8

A financial contract that does not trade on an asset exchange

A forward, swap

Question 9

What is meant by underlying?

Answer 9

Derivatives are secondary securities (financial instruments) derived from asset prices on the primary markets, e.g. commodities, equities.

Question 10

The SPOT price is the price for…

Answer 10

Immediate or almost immediate delivery

Question 11

A put with a strike price of $40.

Price of underlying is $38.

The option is…

ITM? ATM? OTM?

Answer 11

In-the-money