Derivatives security markets Flashcards
What are spot markets?
Immediate agreement of exchange of funds and assets
What are derivative markets?
Future payment and delivery
What are the characteristics of forward contracts?
- Customized contracts
- Not regulated
- High counter party risk
- OTC market
What are the characteristics of future contracts?
- Standardized contracts
- Regulated
- Default risk is diminished
- Occurs in a market
- Price is marked to market daily –> initial margin and then additional according to price fluctuations
What is a position liquidation?
When one of the parties on a futures contract liquidates their position by buying the other side of the contract as well
What is short and long position?
Short = sell Long = buy
What is the difference between an american and european option?
American = can be exercised at any given moment European = only at maturity
What is a call option?
Right to BUY
What is a put option?
Right to SELL
What is the call premium?
Upfront fee to participate in an option
What does it mean an option is IN the money? (call option)
The stock price is greater than the strike price of the option
What does it mean an option is OUT of the money? (call option)
The stock price is lower than the strike price on that option (no option exercise)
The Black-Scholes option pricing model is a function of
- The spot price of the asset
- The exercise price on the option
- The date
- The price volatility
- Risk-free rate of interest
What is the intrinsic value of an option?
Intrinsic value = stock price (mkt) - strike price
At expiration date, an option’s value is = to its intrinsic value
What is the time value of an option?
The value associated with the probability that the intrinsic value (the price) could increase between the option’s purchase and expiration date. As the option approaches maturity, its time value goes to zero