Lecture 1 - Introduction Flashcards
What does it mean when a trader enters into a long forward contract?
She is agreeing to buy the underlying asset for a certain price at a certain time in the future.
What does it mean when a trader enters into a short forward contract?
She is agreeing to sell the underlying asset for a certain price at a certain time in the future.
A network of financial institutions, fund managers, and corporate treasurers who trade directly trade with each other.
Over-the-counter market
A market organized by an exchange where the contracts that can be traded have been defined by the exchange.
Exchange-traded market
‘Options and futures are zero-sum games.’ What do you think is meant by this statement?
Gain (loss) to one side equals the loss (gain) to the other side. In aggregate, the net gain to the two parties is zero. Transaction costs are assumed to be zero in this case.
What is a derivative?
A derivative is an instrument whose value depends on, or is derived from, the value of another asset. Examples: futures, forwards, swaps, options, exotics…
How are derivatives used?
- To hedge risks
- To speculate (take a view on the future direction of the market)
- To lock in an arbitrage profit
- To change the nature of a liability
- To change the nature of an investment without incurring the costs of selling one portfolio and buying another
What is forward price?
The forward price for a contract is the delivery price that would be applicable to the contract if it were negotiated today.
Difference between a futures contract and a forward contract.
Forward contract is traded OTC while a futures contract is traded on an exchange.
What is a call option?
A call option is an option to buy a certain asset by a certain date for a certain price (strike price).
What is a put option?
A put option is an option to sell a certain asset by a certain date for a certain price (strike price).
What is an American option?
An American option can be exercised at any time during its life.
What is a European option?
An European option can be exercised only at maturity.
What is the difference between options and futures/forwards?
A futures/forward contract gives the holder the obligation to buy or sell at a certain price whereas an option gives the holder the right to buy or sell the underlying asset at a certain price.
Explain CCP in the context of derivatives trading.
CCP or central counterparty is a clearing house for over-the-counter derivatives. It
stands between the two parties to the derivatives transaction so that one party does not have to bear the risk that the other party will default. It requires each side to provide margin and performs much the same function as an exchange clearing house.
