Fin.4 Flashcards
bond option
An option to buy or sell a bond at a certain price on or before the option expiry date. Typically traded OTC. Generally, one buys a call option on the bond if one believes that interest rates will fall, causing an increase in bond prices.
Long straddle
Involves going long, i.e., purchasing, both a call option and a put option on some stock, interest rate, index or other underlying. The two options are bought at the same strike price and expire at the same time.
Short straddle
a non-directional options trading strategy that involves simultaneously selling a put and a call of the same underlying security, strike price and expiration date.
3 Valuation Models for Options
Binomial, Black-Scholes, Trinomial
Constant maturity swap
an interest rate swap where the interest rate on one leg is reset periodically, but with reference to a market swap rate rather than LIBOR. The other leg of the swap is generally LIBOR, but may be a fixed rate or potentially another constant maturity rate. Single currency / cross currency swaps.
Forward Rate Agreement (FRA)
a forward contract, an over-the-counter contract between parties that determines the rate of interest to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used along with the termination date and notional value.
Equity swap
A swap where a set of future cash flows are agreed to be exchanged between two counterparties at set dates in the future. One of these ““legs”” is usually pegged to a floating rate such as LIBOR (floating leg). The other leg is based on the performance of either a share of stock or a stock market index (equity leg).
credit default swaption
an option to buy protection (payer option) or sell protection (receiver option) as a credit default swap on a specific reference credit with a specific maturity. The option is usually European, exercisable only at one date in the future at a specific strike price defined as a coupon on the credit default swap.
credit linked note (CLN)
It is structured as a security with an embedded credit default swap allowing the issuer to transfer a specific credit risk to credit investors. The issuer is not obligated to repay the debt if a specified event occurs. This eliminates a third-party insurance provider. It is issued by a special purpose company or trust, designed to offer investors par value at maturity unless the referenced entity defaults. In the case of default, the investors receive a recovery rate.
interest rate cap
a derivative in which the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price. An example of a cap would be an agreement to receive a payment for each month the LIBOR rate exceeds 2.5%.
interest rate floor
a derivative contract in which the buyer receives payments at the end of each period in which the interest rate is below the agreed strike price.
Interest rate collar
the simultaneous purchase of an interest rate cap and sale of an interest rate floor on the same index for the same maturity and notional principal amount.
Warrant
a security that entitles the holder to buy the underlying stock of the issuing company at a fixed exercise price until the expiry date.
Barrier Option
A type of option whose payoff depends on whether or not the underlying asset has reached or exceeded a predetermined price. It can be a knock-out, meaning it can expire worthless if the underlying exceeds a certain price, limiting profits for the holder but limiting losses for the writer. It can also be a knock-in, meaning it has no value until the underlying reaches a certain price.
Asian Option
An option whose payoff depends on the average price of the underlying asset over a certain period of time as opposed to at maturity. An Asian option can protect an investor from the volatility risk that comes with the market.
