L8 - derivatives

Question 1

Introduction

Answer 1

underlying value
risk greater - multiplier and leveraging effect
zero sum market
function
hedge risk
speculate - take view of future direction of market
standardisation - settlement dates, means of measuring variations
Exchange traded ones are more liquid than OTC (futures vs forwards)

Question 2

standardisation

Answer 2

small nr of maturities with spec dates
standard amount of contracts, min. fluctuation in price
market opening times &rules make equality increased
possibility of closing a position before maturity
existence of security deposits
settlement of profit and loss
clearing house

Question 3

Options

Answer 3

the right but not obligation
buy sell given q. of assets
at maturity o before 
at given settlement date
agreed price - strike price

Question 4

Profit Option

Answer 4

CALL
a) buy a call - profit when it is above K exercise
min loss = premium
b) sell a call - onñy profit is the premium paid
loss exercise against you

PUT:: 
a) buy - profit when below K
max loss is premium after K
b) sell: profit is premium when above K ( don´exercise)
loss  if exercise against you

Question 5

option premium

Answer 5

valuing option = calculating pric of contract
charged by purchaser and receive by seller and profit
(payout = 0)

state of option: exercise vs market value
ITM:
call: K < MV (cheaper)
put: k> MV (expensive)

OTM:
opposite - do not exercise - no favourable

ATM:
exercise = market price

Question 6

valuation of options

variables

Answer 6

spot price : + call vs - put
strike price: - call    + put
Interest rate:  + call    - put
maturiy: + both
dividends: -both
only for share options
volatility: + both
(actually unknown, but provides us with value of the premium, implied volatility)

Question 7

Valuation

Answer 7

package of investment in stock + loan
PCP: put + so = call + FV/(1+r)^t

binomial:
loan (if S decreases future value) + 1 share
maturity = diff in price - loan (Future value)
portfolio value vs call payoff
value of call = so - debt (discounted) * P

delta hedging: swing of clal/swings of stock
variation

value of call = so - amount borrowed discounted * delta

risk neutral:
q = (1+r) * (s0-sd) / (su - sd) - s!!!
c0 = qCU + (1-q)Cd / (1+rf) - C!!! (max between 2 prices)

Question 8

futures

Answer 8

fwd traded in organised market
underlying insttrument
settlement date
price of future - future price
price = F = s* e^rt

Question 9

the market

Answer 9

counterparty risk - one does not fulfill (OTC)
prevention through clearing and settlement houses (exchange traded) - guaranteed everyday operations
act as:
a) seller for whoever has committed to buy through derivative contract
b) buyer for whoever wants to sell

Question 10

profit and loss settlement

Answer 10

each session: closing prife Ft compared to the one at start or purchase price
daily profit/loss
clearing house will pay (before next reading day) the profit to one, and changed the amount lost to the other against the security deposit of entity
a) profit entity can withdraw profit amount frm account
b) loss entity has to pay , but if remaining guarantee is less than required minimum (margin call - top up)
otherwise clear up account

market to market - do not have to wait until maturity to receive pofit/loss (forwards - otc) but rather on a daily basis

not necessary to keep it until maturity, can be closed with an operation in opposite direction to that initially carried out
“closes his position” selling another contract