Derivatives Introduction Flashcards

1
Q

What is a derivative?

A

A financial instrument with all three of the following:

  1. ) It has one or more underlyings and one or more notional amounts
  2. ) Requires no initial net investment
  3. ) Its terms require or permit a net settlement.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is an “underlying amount?”

A

A specified price, rate or other variable

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What is a “notional amounts?”

A

A specified unit of measure on which a derivative is valued (e.g. 10,000 bushels)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What is a settlement amount in relation to derivatives?

A

Derived by the multiplication of the notional amount by the underlying. E.g. shares of stock times the price per share.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What are some examples of Derivatives?

A
  1. ) Option Contracts
  2. ) Futures Contracts
  3. ) Forward Contracts
  4. ) Swap Contracts
  5. ) Contracts with characteristics comparable
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is an option contract?

A

A stock option that requires maker to deliver shares of stock at a later time in exchange for a fixed option price.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What is a futures contract?

A

Made through a clearinghouse (e.g. to deliver or receive a commodity or foreign currency in the future at a set price set at the present)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What is a forward contract?

A

Not made through a clearinghouse. Like a futures contract, but made directly between contracting parties

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is a swap contract?

A

An agreement to exchange currencies, debt securities, etc.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

How are derivatives reported?

A

Must be recognized as either an asset or liability and measured at fair value

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

How is a hybrid contract (Host contract with an embedded derivate) accounted for?

A

The embedded derivative should be separated from the host contract and accounted for as a separate derivative instrument if:

  1. ) The economic characteristics and risks of the derivative are not clearly and closely related to the contract
  2. ) The hybrid instrument is not remeasured to fair value each year
  3. ) As a separate instrument, the embedded instrument would meet the requirements of a derivative.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

When an embedded derivative is separated from its host contract, how is it allocated for measurement purposes?

A
  1. ) The derivative is initially recorded at its fair value
  2. ) The difference between the carrying value of the hybrid contract and the fair value of the derivative element is the initial value of the remaining host contract
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is the initial entry to record a derivative (not intended to hedge)?

A

Dr: Investment in Derivative

CR: Cash

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

When a derivative changes in fair value, what is the subsequent recognition?

A
  1. ) Adjust the carrying value of the derivative to current fair value (increase/decrease asset or liability)
  2. ) Recognizing the related gain or loss in current income
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is hedging?

A

A risk management strategy that involves offsetting transactions or positions so that a loss on one transaction or position would be offset (at least in part) by a gain or another transaction or position

How well did you know this?
1
Not at all
2
3
4
5
Perfectly