Finance & Risk 3&4 Flashcards
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What is a financial product?
A contract whose value derives from contingent cashflows paid at specified future times.
Define a cashflow schedule.
A list of payments cₜₖ at times t₁,…,tₙ.
What is the formula for the present value of cashflows?
v = ∑ₖ cₜₖ · dₜₖ, where dₜ is the discount factor to time 0.
Give the discrete compounding discount factor for annual rate r.
dₜ = 1/(1 + r)ᵗ.
What is the continuous‐compounding discount factor?
dₜ = e^(–r·t).
How do you adjust discount factors for f compounding periods per year?
dₜ = (1 + r/f)^(–f·t).
What are the two main cashflows of a bond?
Periodic coupons and the face (notional) value at maturity.
Write the bond price formula.
p = ∑_{k=1}^n c·d_k + F·d_n.
What is yield to maturity (YTM)?
The rate y that solves the bond price formula when d_k = (1 + y)^(–k).
When is a bond trading at a premium?
When p/F > 1 (price above face value).
What does ‘bootstrapping the yield curve’ mean?
Extracting zero‐coupon discount factors sequentially from bond prices of increasing maturities.
Define a forward contract.
An agreement to buy/sell an asset at a predetermined price K on a future date T.
State the no‐arbitrage forward price (continuous compounding).
F₀ = S₀·e^(rT) + cost of carry.
What is the payoff of a European call option?
max(S_T – K, 0).
What is the payoff of a European put option?
max(K – S_T, 0).
State put–call parity.
C – P = S₀ – K·e^(–rT).
What is an interest rate swap?
A contract exchanging fixed‐rate payments for floating‐rate payments on a notional principal.
Name two main risks faced by banks.
Credit risk (borrower default) and liquidity risk (funding dry‐up).
What is the primary risk for asset managers?
Market risk from changes in security prices.
How do insurers manage risk?
Pool many policies (diversification) and invest premiums in securities.
What role do broker‐dealers play?
They make markets by quoting buy/sell prices and managing trading‐book risks.
