Derivatives: Markets and Instruments

Question 1

American-Style

Answer 1

Type of option contract that can be exercised at any tile up to the options expiration date

Question 2

Arbitrage

Answer 2

The simulataneous purchase of an undervalued asset or portfolio and sale of an overvalued but equivalent asset or portfolio, in order to obtain a risk less profit on the price differential.

Question 3

At the money

Answer 3

An option in which the underlying as price equals the exercise price

Question 4

Call

Answer 4

An option that gives the holder the right to buy an underlying asset from another party at a fixed price over a specific period of time

Question 5

Call Option

Answer 5

An option that gives the holder the right to buy an underlying asset from another party at a fixed price over a specific period of time

Question 6

Cash markets

Answer 6

Markets in which assets are traded for immediate delivery.

Question 7

Cash prices

Answer 7

The price of an asset for immediately delivery.

Question 8

Cash-settled forwards

Answer 8

Cash-settled forward contracts, used predominately with respect to foreign exchange forwards

Question 9

Clearing

Answer 9

The process by which the exchange verifies the execution of a transaction and records the participants’ identities

Question 10

Collateralized bond obligations

Answer 10

A structured asset-backed security that is collateralized by a pool of bonds.

Question 11

Collateralized debt obligation

Answer 11

Generic term used to describe a security backed by a diversified pool of one or more debt obligations.

Question 12

Collateralized loan obligations

Answer 12

A structured asset-backed security that is collateralized by a pool of loans.

Question 13

Collateralized mortgage obligation

Answer 13

A security created through the securitization of a pool of mortgage-related products (mortgage pass-through securities or pools of loans).

Question 14

Contingent claims

Answer 14

Derivatives in which the payoffs occur if a specific event occurs; generally referred to as options.

Question 15

Contracts for differences

Answer 15

Cash-settled forward contracts, used predominately with respect to foreign exchange forwards.

Question 16

Credit default swap (CDS)

Answer 16

A type of credit derivative in which one party, the credit protection buyer who is seeking credit protection against a third party, makes a series of regularly scheduled payments to the other party, the credit protection seller. The seller makes no payments until a credit event occurs.

Question 17

Credit derivatives

Answer 17

A contract in which one party has the right to claim a payment from another party in the event that a specific credit event occurs over the life of the contract.

Question 18

Credit-linked note (CLN)

Answer 18

Fixed-income security in which the holder of the security has the right to withhold payment of the full amount due at maturity if a credit event occurs.

Question 19

Credit spread option

Answer 19

An option on the yield spread on a bond.

Question 20

Daily settlement

Answer 20

The revaluation of a financial asset or liability to its current market value or fair value.

Question 21

Derivatives

Answer 21

A financial instrument whose value depends on the value of some underlying asset or factor (e.g., a stock price, an interest rate, or exchange rate).

Question 22

European-style

Answer 22

Said of an option contract that can only be exercised on the option’s expiration date.

Question 23

Exercise price

Answer 23

The fixed price at which an option holder can buy or sell the underlying.

Question 24

Fixed-for-floating interest rate swap

Answer 24

An interest rate swap in which one party pays a fixed rate and the other pays a floating rate, with both sets of payments in the same currency.

Question 25

Forward commitments

Answer 25

Class of derivatives that provides the ability to lock in a price to transact in the future at a previously agreed-upon price.

Question 26

Forward price

Answer 26

The fixed price or rate at which the transaction scheduled to occur at the expiration of a forward contract will take place. This price is agreed on at the initiation date of the contract.

Question 27

Futures price

Answer 27

The agreed-upon price of a futures contract.

Question 28

Hedge portfolio

Answer 28

A hypothetical combination of the derivative and its underlying that eliminates risk.

Question 29

Implied volatility

Answer 29

The volatility that option traders use to price an option, implied by the price of the option and a particular option-pricing model.

Question 30

In the money

Answer 30

Options that, if exercised, would result in the value received being worth more than the payment required to exercise.

Question 31

Initial margin

Answer 31

The amount that must be deposited in a clearinghouse account when entering into a futures contract.

Question 32

Law of one price

Answer 32

The condition in a financial market in which two equivalent financial instruments or combinations of financial instruments can sell for only one price. Equivalent to the principle that no arbitrage opportunities are possible.

Question 33

Limit down

Answer 33

A limit move in the futures market in which the price at which a transaction would be made is at or below the lower limit.

Question 34

Limit up

Answer 34

A limit move in the futures market in which the price at which a transaction would be made is at or above the upper limit.

Question 35

Locked limit

Answer 35

A condition in the futures markets in which a transaction cannot take place because the price would be beyond the limits.

Question 36

Long

Answer 36

The buyer of a derivative contract. Also refers to the position of owning a derivative

Question 37

Maintenance margin

Answer 37

The minimum amount that is required by a futures clearinghouse to maintain a margin account and to protect against default. Participants whose margin balances drop below the required maintenance margin must replenish their accounts.

Question 38

Margin

Answer 38

The amount of money that a trader deposits in a margin account. The term is derived from the stock market practice in which an investor borrows a portion of the money required to purchase a certain amount of stock. In futures markets, there is no borrowing so the margin is more of a down payment or performance bond.

Question 39

Margin bond

Answer 39

A cash deposit required by the clearinghouse from the participants to a contract to provide a credit guarantee.

Question 40

Margin call

Answer 40

A request for the short to deposit additional funds to bring their balance up to the initial margin.

Question 41

Mark to market

Answer 41

The revaluation of a financial asset or liability to its current market value or fair value.

Question 42

Non-deliverable forwards

Answer 42

Cash-settled forward contracts, used predominately with respect to foreign exchange forwards.

Question 43

Notional principal

Answer 43

An imputed principal amount.

Question 44

Open interest

Answer 44

The number of outstanding contracts in a clearinghouse at any given time. The open interest figure changes daily as some parties open up new positions, while other parties offset their old positions.

Question 45

Option

Answer 45

A financial instrument that gives one party the right, but not the obligation, to buy or sell an underlying asset from or to another party at a fixed price over a specific period of time.

Question 46

Option premium

Answer 46

The amount of money a buyer pays and seller receives to engage in an option transaction.

Question 47

Out of the money

Answer 47

Options that, if exercised, would require the payment of more money than the value received and therefore would not be currently exercised.

Question 48

Performance bond

Answer 48

A cash deposit required by the clearinghouse from the participants to a contract to provide a credit guarantee.

Question 49

Price limits

Answer 49

Limits imposed by a futures exchange on the price change that can occur from one day to the next.

Question 50

Put

Answer 50

An option that gives the holder the right to sell an underlying asset to another party at a fixed price over a specific period of time.

Question 51

Put Option

Answer 51

An option that gives the holder the right to sell an underlying asset to another party at a fixed price over a specific period of time.

Question 52

Risk management

Answer 52

The process of identifying the level of risk an organization wants, measuring the level of risk the organization currently has, taking actions that bring the actual level of risk to the desired level of risk, and monitoring the new actual level of risk so that it continues to be aligned with the desired level of risk.

Question 53

Settlement

Answer 53

The process that occurs after a trade is completed, the securities are passed to the buyer, and payment is received by the seller.

Question 54

Settlement price

Answer 54

The official price, designated by the clearinghouse, from which daily gains and losses will be determined and marked to market.

Question 55

Short

Answer 55

The seller of an asset or derivative contract. Also refers to the position of being short an asset or derivative contract.

Question 56

Spot markets

Answer 56

Markets in which assets are traded for immediate delivery.

Question 57

Spot prices

Answer 57

The price of an asset for immediately delivery.

Question 58

Total return swap

Answer 58

A swap in which one party agrees to pay the total return on a security. Often used as a credit derivative, in which the underlying is a bond.

Question 59

Transparency

Answer 59

Said of something (e.g., a market) in which information is fully disclosed to the public and/or regulators.

Question 60

Underlying

Answer 60

An asset that trades in a market in which buyers and sellers meet, decide on a price, and the seller then delivers the asset to the buyer and receives payment. The underlying is the asset or other derivative on which a particular derivative is based.