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CFA L2 2015 > Derv > Flashcards

Derv Flashcards

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1
Q

3 types of CDS

A
  1. Single name CDS: reference obligation is FI
  2. Index CDS
  3. Tranche CDS
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2
Q

CDS pays when:

A

When the reference entity(issuer) defaults in ANY other issue ranked park passu or higher

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3
Q

CDS payoff

A

Based on MV of cheapest to deliver bond with same seniority as reference obligation

CTD: Debt purchased at lowest cost but same seniority

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4
Q

CDS:

Protection buyer/seller

A

Insurance contract; credit risk protection only

Protection buyer pays CDS spread
Protection seller longs credit risk
FV: notional; amt to be protected

Protection leg: contingent pmt seller makes to buyer
Premium leg: pmt buyer makes to seller

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5
Q

Hazard Rate

A

Probability that an event will occur given that it hasn’t already occurred

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6
Q

Credit curve

A

Credit spread for a range of maturities of company’s debt make up its credit curve

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7
Q

IR Cap

A

Agreement which one party agrees to pay when benchmark IR > strike rate (cap rate); portfolio of call options on LIBOR (caplets)

Buyer: call on LIBOR

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8
Q

IR Floor

A

Agreement which one party agrees to pay when benchmark IR

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9
Q

For a call option on a FI:

A

When IR rises, price falls, call option value decreases

When IR falls, price rises, call option value rises

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10
Q

For a put option on FI:

A

When IR rises, price falls, put option value rises

When IR falls, price rises, put option value falls

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11
Q

Interest rate collar

A

Issuer: buys cap (protect from high IR) and sells a floor
Bond holder: buys floor (protect from low IR) and sells the cap.

The net prem paid by an ISSUER for a collar = (prem paid for cap) - (prem received for selling the floor). Issuer can set the exercise rates on the cap and floor such that the price received for floor = price paid for cap. Eliminates the upfront cost of buying interest rate call options, and result in a zero-cost collar for the issuer.

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12
Q

2 types of collars

A
  1. Buy cap, sell floor
    Investor has LIBOR liability, borrowing cost will stay within collar (floor-cap)
  2. Buy floor, sell cap
    Investor has LIBOR asset, return will stay within collar (floor-cap)
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13
Q

Fiduciary Call

A

(Call option on stock) + (zero coupon rf bond)

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14
Q

Protective Put

A

(Put option on stock) + (share of stock)

Pay prem for limited downside
Unlimited upside

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15
Q

Hedging (Covered Call)

A

Receive call premium

No upside potential

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16
Q

Delta Hedging

A

Hedge needs to be continually rebalanced even if stock price doesn’t chg, b/c delta chgs as time passes and option approaches maturity

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17
Q

1-period binomial model

A

U: size of up move
D: 1 - U
prob(u): prob of up move
prob(d): 1 - prob(u)

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18
Q

Risk Neutral Probability

A 
prob(u) = (1+ rf - D)/(U-D)
prob(d) = 1 - prob(u)
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19
Q

Lower/Upper Bounds

call option

A

Lower: Max(0, So- (X/(1+rf)^t))

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20
Q

Lower/Upper Bounds

put option

A

Lower:
European Put: Max(0, (X/(1+r)^t) - So)
American Put: Max(0,X-So)

21
Q

Price options on bonds

A

1) Price bond at each node using projected IR
2) Calculate intrinsic value of option at each node @ maturity of the options
3) Bring the terminal option values determined in step 2 back to today

22
Q

BSM assumptions

A

1) underlying price follows lognormal distribution
2) rf constant and known
3) vol of underlying is constant and known
4) mkts are frictionless
5) underlying has no CFs
6) European options only

23
Q

BSM inputs

A

1) Stock price
2) Exercise price
3) Stock volatility
4) Time to expiration
5) rf rate

24
Q

Vega

A

measures sensitivity of option price to chgs in volatility of So

25
Q

Rho

A

option price doesnt chg much with chgs in rf rate

26
Q

Theta

A

Time

27
Q

Delta
Vega
Rho
Theta

A 
Calls:
Delta > 0
Vega > 0
Rho > 0
Value approaches $0 as option approaches maturity (Theta  0
Rho
28
Q

Deep ITM puts have a delta of

A

-1

29
Q

Deep OTM calls have a delta of

A

0

30
Q

Call option delta is between 0 and 1 if…

A

Assuming the So doesn’t change

1) call option is OTM, the call delta moves closer to 0 as time passes
2) ITM the delta moves closer to 1 as time passes

31
Q

Gamma

A

Measures rate of chg in delta as the So chgs

graph: upside down v
ATM and close to expiration options: higher gammas
ITM/OTM: small gammas

32
Q

TBill Futures

A

Eurodollar & Tbill futures settled in cash

Discount factor: 1- (quote*(t/360))

Rf Yield = (Par - discount factor)/(discount factor)

FP = So*[(1+rf)^t]

33
Q

TBond Futures

A

FP = (bond price*[(1+rf)^t]) - FVC)/Conversion factor

34
Q

Stock Futures

A

(So*[(1+rf)^t] - FV(Div)

35
Q

EQ Div Futures

A

Soe^[(rf(cc) - div yield(cc))t]

36
Q

FX Futures

A

So*{ [(1+rd)^t]/[(1+rf)^t] }

37
Q

Put Call Parity

A

Co + X/[(1+rf)^t] = Po + So

38
Q

FX Swap Price

A

1 party receives, 1 party pays

stick to curncy in qs
freq: pmts
1) calc PV(interest & principal)
use rf(A/360)
2) convert a side using current spot rate
3) net out both parties to see who pays
39
Q

Swap Rate

A

1-(last discount factor)/ (sum of discount factors)

40
Q

Payer Swaption (Long vs Short)

A

Long Payer:
when IR falls, swaption value decreases

Short Payer:
when IR falls, swaption value increases

41
Q

Receiver Swaption (Long vs Short)

A

Long Receiver:
when IR falls, swaption value increases

Short Receiver:
when IR falls, swaption value decreases

42
Q

Payer vs Receiver Swaption

A

Payer swaption: right to enter swap to pay the fixed leg and receive the floating leg.

Receiver swaption: right to enter swap to receive the fixed leg, and pay the floating leg.

43
Q

At initiation of IR Swap

A

both parties exposed to potential credit risk (low exposure)

44
Q

Credit Risk on Payer Swaption

A

Long position (fixed receiver) exposed to credit risk due to chance counterparty will default if swaption expires ITM

Short position isn’t exposed to credit risk b/c they’ll not receive a pmt at maturity no matter if the swaption expires in or out of the money

45
Q

Eurdollar vs Tbill Futures

A

the Eurodollar contract is better at hedging LIBOR based investments b/c it’s a LIBOR based contract

T-bill contract is based on T-bill rates, not perfectly correlated to LIBOR

46
Q

Long Eurodollar Contract

A

If IR falls, yield on LIBOR investment will fall, but the decrease will be offset by gains on a long Eurodollar futures contract

47
Q

2 year floor

A

equal to 1 yr European put option plus value of a 2 yr put option (floorlet)

A 1yr floorlet with an annual payoff is the same as a 1yr put option on annual LIBOR

value of 2 yr put option is equal to value of 2 yr floor LESS value of 1 yr put option

48
Q

Call Option (European vs American)

A

Early exercise is not valuable for call options on NON-DIVIDEND PAYING stocks, so American call = European call

CFA L2 2015 (7 decks)

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