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RMIN 317 > Final > Flashcards

Final Flashcards

1
Q

What is Hedging and Why is it Done?

A
  • investment that protects your finances from a risky situation
  • done to minimize or offset chance that your assets will losse value
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2
Q

2 Subcategories of Derivatives

A
  • Option-Based Contracts
  • Forward-Based Contracts
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2
Q

Derivative

A

a contract whose payoff (or value) is determined by the value of something else (underlying asset)
-> “value that’s derived from something else”

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3
Q

Forward Contract

A

agreement BETWEEN 2 PARTIES to exchange a commodity, security, or foreign currency at specified date in future at pre-agreed price

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4
Q

Futures Contract

A

contract TRADED on an EXCHANGE that allows an entity to buy or sell a SPECIFIED QUANTITY of commodity or a financial secutiy at a specified price on a specified future date

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5
Q

Characteristics of Forward Contracts

A
  • privately negotiated, over-the-counter (OTC) contract
  • user promises and thus is OBLIGATED to buy or sell an asset at a specified future date -> NOT AN OPTION, MUST UPHOLD
  • sold at specified price at contract initiation (forward price)
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6
Q

Forward Price

A

price specified at the initiation of a forward contract

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7
Q

5 Features of Forward Contracts

A
  • Linearity
  • No Money Down
  • Settlement at Maturity
  • Counterparty Risk
  • Customization
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8
Q

Forward Contracts - Linearity

A

payoffs are symmeterical -> one party’s gain is another party’s loss

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9
Q

Forward Contracts - No Money Down

A

in theory, no money is exchanged at initiation

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10
Q

Forward Contracts - Settlement at Maturity

A

in theory, no money is exchanged until maturity date of contract

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11
Q

Forward Contracts - Counterparty Risk

A

liklihood the other party unable to meet its obligation at maturity date

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12
Q

Forward Contracts - Customization

A

customized to buyers and sellers preferances (OTC); not publicly traded on an exchange

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13
Q

Characteristics of Futures Contracts

A
  • STANDARDIZED contracts on formal exchange
  • there’s DAILY RESETTLEMENT (“marking to market” or “cash settled”) between parties through a clearing house
  • parties required to post PERFORMANCE BOND (margin) -> this collaterizes the transaction
  • all above characteristics increase liquidity, increase competitive pricing, and reduce counterparty risk
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14
Q

What do Forward (Future) Prices Suggest?

A

the forward price is a “no-abitrage price” determined by balanced supply and demand -> any forward price above or below this price could lead to 0 cost, riskless profits for traders

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15
Q

Option Based Contract

A

contract giving HOLDER the RIGHT, but NOT obligation, to buy or sell an asset at a specified price at any time during a specified period in the future -> the WRITER of option is OBLIGATED to perform obligation on option contract

16
Q

Call Option

A

the right, not obligation, to BUY an asset

17
Q

Put Option

A

the right, not obligation, to SELL an asset

18
Q

American Option

A

an option that can be exercized at ANY TIME UNTIL expiry date

19
Q

European Option

A

an option that can be exercised ONLY ON expiry

20
Q

Bermudan Option

A

an option that can be be exercised ONLY during a PREDIFINED PORTION of its life

21
Q

Option Based Contract Characteristics

A
  • buyer of option acquires right NOT OBLIGATION to initiate specific transaction in exchange for payment of a premium
  • under specific terms and conditions
22
Q

4 Features of Option Based Contracts

A
  • Non-Linearity
  • Money Down
  • Settlement at Exercise
  • Customization
23
Q

Option Based Contracts - Non-Linearity

A

payoffs are asymmetrical since owner of option not obligated to exercise option -> one party’s gain not necessarily another party’s loss

24
Q

Option Based Contracts - Money Down

A

at initiation, an option premium is paid to buyer from seller

25
Q

Option Based Contracts - Settlement at Exercise

A

options settled at exercise when money is potentially exchanged

26
Q

Options Based Contracts - Customization

A

options available OTC and on formal exchanges

27
Q

When are options exercised?

A

when they are “in the money”

28
Q

Insurance ________ wealth if a loss does not occurs

A

decreases

29
Q

Insurance _________ increases wealth if a loss does occur

A

increases

30
Q

Insurance _________ the _________ of wealth around the expected level of wealth

A

reduces; variability (standard deviation)

31
Q

Factors Affecting Demand for Insurance

A
  • Premium Loadings
  • Income and Wealth
  • Information
  • Other Sources of Indemnity
  • Non-Monetary Losses
32
Q

What does homeowner insurance cover?

A
  • first-party property
  • third-party liability
  • indirect losses
33
Q

What is homeowners insurance?

A

a multiple line, multiple peril policy

34
Q

What is Section 1 in Homeowners Insurance, and what does it include?

A

Section 1 is property and it includes:
A. Dwelling Building
B. Detatched Private Structures
C. Personal Property
D. Additional Living Expenses

35
Q

What is Section 2 of Homeowners Insurance, and what does it include?

A

Section 2 is Liability and it includes:
E. Personal Liability
F. Voluntary Medical Payments
G. Voluntary Payment for Property Damage
H. Voluntary Compensaiton for Residence Employee

RMIN 317 (2 decks)

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