Financial Risk Flashcards
Forward contract
tailor-made binding agreement to exchange a set amount of goods at a set future date at a price agreed today
Future contract
standardised contract to buy ot sell a specific amount at a particular price on a set future date
Call option
~ entitled to buy
~ investors starts by buying
Pull option
~ the right to sell
~ borrower always sells 1st
Over-the-counter
traded on an exchange or betwn two parties
Traded options
standadised and bought and sold on secondary markets e.g. Euronext
Intrinsic value
computed as if expiry date is today
Premium =
intrinsic value + time value
Forward contract: Pros + Cons
+ tailored contract
~ set commodity price in advance (no downside or upside risk)
- binding contract: can’t get out if customer cancels
Future contract: Pros + Cons
~ set commodity price in advance (no downside or upside risk)
- binding contract: can’t get out if customer cancels
- standardised contract
Options: Pros + Cons
- have to pay a premium
+ reduces downside risk
+ enables upside potential
Methods used to reduce interest rate risk
~ FRA
~ Futures
~ Options
~ Swaps
Forward Rate Agreements (FRA): Disadvantages
~ only for loans of at least £500k
~ difficult to obtain for >1yr
~ remove upside potential
Forward Rate Agreements (FRA): Advantages
~ no downside risk
~ can be tailored (amount +duration)
Swaps: Advantages
~ able to switch from floating to fixed rate
~ arrangement costs < terminal costs
~ available for longer periods
~ tailored
