Mid Sem

Question 1

Forwards

Answer 1

OTC agreement between 2 parties: buyer/ sell at future date, with the price agreed upon today (t=0).

Question 2

Futures

Answer 2

traded on an exchange and settled daily. Protects against default risk.

Question 3

open and close. position

Answer 3

open = enter contract via broker or online exchange + referred to delivery month
close = enter in opposite trade (if not at expiry cash is settled)

Question 4

relationship b/w future p and spot p

Answer 4

converge when approaching expiry (if not = arbitrage)

Question 5

margins

Answer 5

invest cash to broker, minimise default risk

Question 6

marking to market

Answer 6

balance adjusted to reflect daily settlement

Question 7

settlement change

Answer 7

diff bw yesterday and today settlement price

Question 8

regulation

Answer 8

regulation = protect the public interest
regulators = prevent questionable trading practices on the floor os exchange or outside groups

Question 9

forward vs future

Answer 9

priv contract vs exchange
not stand vs stand
specific date vs range
maturity vs daily
close date on delivery vs before
credit risk vs none

Question 10

forward at maturity

Answer 10

At maturity (t=T), the long buys the asset at the agreed price.

Question 11

futures Long position

Answer 11

profit when the underlying asset’s price at maturity exceeds the agreed price. |–/–

Question 12

futures short position

Answer 12

profit when the underlying asset’s price at maturity is below the agreed price. |–--

Question 13

open interest stock

Answer 13

total no. of contracts that haven’t been liquidating by an offsetting transaction or physical delivery.
no. long position = no. short postions

Question 14

open interest change

Answer 14

no. of net new positions

Question 15

volume (flow)

Answer 15

during a specified period is
no. of purchases = no. of sales

Question 16

price limits

Answer 16

2/3 of exchange - commodities
based on the volatility of underlying
partial substitute for margins

Question 17

short hedges

Answer 17

sell asset in future, lock in price, asset owned
spot long : |–/– future short : |–--

Question 18

long hedges

Answer 18

purchase asset in future , want to lock in price
spot short : |–-- future long : |–/–

Question 19

should companies hedge?

Answer 19

for:
use futures to minimise risk, focus on the main business
against:
well diversified - own hedging decisions
gain on underlying is difficult

Question 20

basis risk

Answer 20

imperfect hedge - risky when don’t know date closed out before expiry

Question 21

cross hedging

Answer 21

asset to be hedged is not same as underlying

Question 22

use of stock index futures (fund managers perspective)

Answer 22

cheaper way to get out of the market for a short period of time
hedge systematic risk
no. contracts shorted + CAPM

Question 23

hedge ratio

Answer 23

mvhr = size of future position/size of spot exposure

Question 24

3 approaches to short/long hedges

Answer 24

1. transactions actually occur
2. offsetting payoffs assist hedge ratio
3. basis risk

Question 25

basis risk formula

Answer 25

basis(t) = spot price of hedge asset - future of contract

Question 26

arbitragee

Answer 26

price difference bw markets - risk free profit

Question 27

investment assets

Answer 27

invest - help for investment purposes –> can price forward + futures off spot via arbitrage

Question 28

short selling
IMPORTANT!

Answer 28

sell securities you don’t own , broker borrows and sells on spot , you buy back and return
price falls = sell high , buy low
pay dividends

Question 30

short sale constraint

Answer 30

not needed for the forward price equation, only some people hold asset only for investment purposes

Question 31

Invest asset: known yield - stock index futures, currentcy futures

Answer 31

q = avg yield over life of contract

Question 32

consumption assets

Answer 32

not able to pirce forwards+futures off spot via arb

Question 33

valuation

Answer 33

the value of futures contract is zero - value in margin account

Question 34

ESG

Answer 34

environmental social governance - less exposed to tail risks
e.g,. EUREX, NASDAQ

Question 35

future + expected spot prices

Answer 35

F= E –> unbiased estimate of S
F< E –> normal backwardation
F>E –> contango

Question 36

option types

Answer 36

call - buy
put - sell

euro - only at maturity
American - any time

Question 37

option positions

Answer 37

long call, long. put, short call , short put –> learn diagrams

Question 38

moneyness

Answer 38

in money = S>K for call
out money = S< K for call
at. money S=K for call/ put

euro exercise when in money on expiry date.

Question 39

intrinsic value

Answer 39

max of zero , value of option if exercised immediately.
Max(S-K, 0). call
Max (K-S,0) put

Question 40

time value

Answer 40

option may in crease in value due to volatility in underlying

Question 41

factors affecting option prices

Answer 41

look at table
stock p increase : call increase
strike p decrease: call increase
div reduce stock p
increase in risk free rate - decrease PV of K

Question 42

upper bound

Answer 42

call never worth more than stock
American put never. more. than exercise price

Question 43

lower bound

Answer 43

c>_ max (S-Ke-rt, 0)
violation. of lower bound = arbitrage profit

Question 44

put - call parity

Answer 44

price of a call option and a put option with the same strike price and expiration date should have a specific relationship to the price of the underlying asset.

Question 45

early exercise

Answer 45

American exercise early - exception is American call on non div paying stock
no income sacrificed, delay paying strike , call provide insurance against stock price falling below strike.

Question 46

the effect of dividends

Answer 46

when paid, optimal to exercise American call prior to ex date
final expiry close to T, div is large, multiple div better to exercise before last

Question 47

option value

Answer 47

intrinsic + time value