Exam Flashcards
Put-call parity
Ties the premiums of call and put option together
Option pricing
The process of finding the appropriate premium at which it makes sense for the writer to write the option and for the buyer to the buy the option.
Risk-free asset
Has a certain future return. Because they are so safe, the return on risk-free assets is very close to the current interest rate.
Contango
A situation where the futures price of a commodity is above the expected spot price.
Option collar
Involves writing options to finance the purchase of other options
Vertical integration
Entails a merger of two firms that have opposite exposures to a commodity price
Backwardation
Backwardation relates to the price of a futures contract and the contract’s time to expire. As the contract approaches expiration, the futures contract trades at a higher price compared to when the contract was further away from expiration. This is because the spot price is above the futures price, and the contract and spot price must eventually converge, so the future’s price rises toward the spot price.
Déterminants of exchange rates
- Level of interest rates
- Changes in interest rates
- Inflation
- Current account imbalances
- Terms of trade
- Political stability and economic performance
The uncovered interest rate parity
States that currencies with high (low) interest rates should depreciate (appreciate) in the future
Operational hedges
- Netting
- Purchasing and manufacturing
- Transfer to customers or suppliers
Netting
A process in which the firm matches its foreign currency inflows and outflows both in terms
Two main financial hedges that firms can use to offset exchange rate exposures
Derivatives and foreign currency debt
Determinants of interest rates
- Supply of funds and demand for loans
- Fiscal policy
- Monetary policy
- Inflation
Interest rate cap
Series of interest rate call options, sometimes called caplets.
Interest rate floor
Series of interest put options
