Introduction to derivatives Flashcards
What is the definition of derivative contract?
It is a financial contract whose value is derived from the value of an underlying asset.
In another word: The value of the derivative contract is determined by the evolution of the price of an underlying asset (stocks, intere=rates, stock market index, raw material (gold, oil) etc..)
What are the main type of derivatives contract?
- Fowards
- Futures
- Options
- Swaps
What is another word for derivative
“contigent claims”
Definition general of foward and future contracts?
both of them are contracts of an underlying asset that are set for a pre-specific price at a specific date in the future
Explain the difference between futures and fowards contract
Features:
Standarization:
- Fowards: Customized / Not Standardized (ilimited in term of size, quality and delivery time)
- Futures: Highly Standardized (limited in term of size, quality and delivery time)
Settlement:
- Fowards: Settled at the end of the contact
- Ftures: settle on a daily basics
Counterparty risk:
- Fowards: High risk because the performance of the contract depond on the credithworthiness of both parties
- Futures: Less risk due to the Clearing house that acts as an guarentor for the contract
Trading:
- Fowards: OTC (Directly in contact with both parties) = Private exchange between both parties
- Futures: Traded on organized echange
Long position and short position def
Long position: is the buyer of the specify underlying asset at a pre-specific price at a specific point in the futre
Short postion: is the seller of the specific underlying asset at a pre-specific price at a soecific poin in the futures
What is the pay-off (profit) for Long and Short positions?
Consider Ft, the price of the stock (on the market) when the contract expired = the FOWARD PRICE.
And St, Known as Spot price is pre-specify price set for both parties.
Long positions (buyer) = Ft - St
Short positions (Seller) = St - Ft
The negative or positive Profits depends on how well boht parties perform.
Exemple:
- If Long = - profits = Negative = poor performance
- If Short = - profits = Negative = no profits but a lost.
What’s the definition of hedging
Limit the potential of loss
what is the definition of commodity?
it’s a type of product that the short position is selling to the long position
What is the relationship between long position and short position
Buyer is buying a commodity (a stock of apple for example) from a seller and in exchange the seller receive money from the buyer.
Trading strategies for hedgers and speculators? in term of long position and short postion
Hedgers (Since they want to limit potential of a loss = he “protects” the value underlying assets):
- Short postion: he protect against a rise in purchase price (because he wants to sell to make a profit)
Long position: he protects against a fall of rise (because he wants to buy)
Speculator: (seek to profits from price mouvement)
- Short postions: he believes that the price will fall
-Long positions: he believes the price will rise.
What do you expect the price to be when you go long and short?
Long: Buy low, sell high.
Short: Sell high, buy low.
Does a long position become a short position when selling a stock? and vice-verca?
No when a long position sells the contract it simply mean closing the position.
The same as short, when the short position is buying a stock it mean he/ she borrowed the stock (margin trading) to sell it later at higher price.
Long: Buying an asset with the expectation that the price will go up, so that can sell it later
Short: You might ask how can you sell a stock that you don’t have? -> You borrow the asset from the broker. It’s called margin trading.
The goal is to borrow assets from the broker and sell it higher than the price of the asset in order to make a profit and buy the same stock at a lower price so you can give back the money to the broker.
