LIBOR (swap), forwards and options Flashcards
what makes a financial derivative
-instrument
-contract
-OTC or exchange
what is a forward contract?
Agreement to buy or sell an asset at a future date for a pre-determined price
-one party assumes a long position, while the other a short
-long agrees to buy
-short agrees to sell
Forward-Forward/ Forward Interest rate
borrows or deposits on a forward date and ends on another
-term, amount and interest is fixed
Quiz. you need to borrow for a 3 month period, starting in 2 months. you think interest will rise in the next 2 months
- interest rate for 2 months is 5.6/5.7%
-interest rate for 5 months is 5.3/5.4%
what do you do?
borrow for 5 months at 5.4% and deposit the whole borrowing for 2 months at 5.6%
what’s an option?
-contract which specifies the price (exercise) at which an amount of currency can be bought at a date in the future, called the expiration date
-major currencies have options for all types of interest rates/ interest rate products.
-interest rate options 3 groups; floating, fixed and spread options
-can be OTC or exchange
rights of holder in option contract
holder has the right to buy or sell an underlying asset at a specified price. purchase price called premium
types of options
- call option: gives the right to buy
- put option: give the right to sell
- American option: option exercised at anytime during life
- European option: option only exercisable at end of life
what do options give the right to?
to borrow/lend deposits funds at a specified rate of interest for am agreed period in the future
-to purchase/sell currencies at agreed exchange rates at future dates
-most commonly have shares as the underlying asset
You buy a share for £2, its exercise is £50 today.
a) will you sell it if its price is now £55
b) will you sell it if its price is below £50
c) would you sell it between £50-52
a) yes because £55-£52=£3 profit
b) no, you will hold as you need to cover some of your losses
c) yes as it could cover some of the cost
Example. Put Option
buy share for £2 its ex is £50, but its spot is £30
option holder can sell t for £50 and buy it in the spot market at £30 making profit equal to (50-30-2=18)
Currencey option
like futures and forwards, options are a way of buying or selling a currency at a certain point in the future.
-every currency option is called both a call and a put option as your buying one currency and selling the other
e.g. buyer of EUR has the right to buy a face amount of EUR for exchange of USD, USD is determined by the strike price of the option
can be considered the opposite as well
