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FM 2557 > Midterm #1 > Flashcards

Midterm #1 Flashcards

1
Q

What is Trading Volume

A

The amount of individual product that was traded daily, monthly, etc…

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2
Q

What is Notional Value

A

(Units in contract x Spot Price)

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3
Q

What is Open Interest

A

The total number of contracts for which counter parties have a future obligation to perform

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4
Q

3 Groups of Investment

A
  1. Equity (stock/shares)
  2. Debt (bonds/banknotes)
  3. Derivatives (forwards/futures/options)
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5
Q

How is Market Value determined

A

Determined by the market value of a firms total assets minus its debt

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6
Q

Properties of Dividends

A
  • not guaranteed

- not always reflective of the profitability of the firm

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7
Q

Dividend Yield

A

Annual Dividend / Market Value

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8
Q

Bond Price > Par Value

A

Sell at Premium

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9
Q

Bond Price = Par Value

A

Sell at Par

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10
Q

Bond Price < Par Value

A

Sell at Discount

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11
Q

4 Uses for Derivatives

A
  1. Risk Management
  2. Speculation
  3. Reduce Transaction Costs
  4. Regulate Arbitrage
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12
Q

Describe derivatives and risk management

A

Used for companies to reduce risk

  • reinsurance companies
  • a company doing business in multiple countries to hedge currency risk
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13
Q

Derivatives and Speculation

A
  • buying a call/put

- bet on the price

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14
Q

How can derivatives reduce transaction costs

A
  • instead of buying a commodity with transaction cost and storage fee, you can hold cash and buy future contract
  • make money on the fluctuation of gold without owning gold
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15
Q

What is a Market Maker

A

Typically large banks that are in place to ensure trades are done seamlessly. Without market makers, there would likely be little liquidity. In other words, investors who want to sell securities would be unable to unwind their positions due to a lack of buyers in the market.

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16
Q

What is “offer/ask price”

A

Cost of purchasing a security from market maker

Must pay HIGH end

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17
Q

What is “bid price”

A

Price you can get for selling a security to a market maker

Must accept LOW end

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18
Q

Why are there 2 prices for buying and selling

A

There are 2 prices because the Market Makers need to make money.
Ex.) Ask: 102/104, this means the market maker would pay you $102 for the security then would sell it for $104

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19
Q

Advantages/Disadvantages of Market Orders

A

+: the trade will be executed as soon as possible

-: could have got better price if you were patient

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20
Q

Advantage/Disadvantage of Limit Orders

A

+: can obtain a better price

-: possibility that the order is never filled

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21
Q

What is a Stop-Loss Order

A
  • Always a sell

- Creates market order that will sell asset if its price falls below specified price (stop the loss by selling)

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22
Q

What is Short Selling

A
  • Selling an asset that you don’t own
  • Borrow asset from someone and sell it immediately then buy assets back at a later date and return to owner
  • Short-Sell a stock if you see it is overvalued
    (Shon said to short Tesla right before it crashed)
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23
Q

What does “Short Squeezed” mean

A

Short Squeezed is if the short-seller has difficulty buying back the asset and returning it to the owner

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24
Q

What is “long position”

A

Long Position = Buying something

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25
Q

What is “short position”

A

Short Position = Selling something

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26
Q

Haircut

A

Requiring a haircut means that the size of the position taken by the short seller is limited by the amount of capital they can provide

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27
Q

What is payoff

A

Cashflow

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28
Q

What is profit

A

Cashflow - AV(cost of initial investment)

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29
Q

What is Stock Index

A

Average price of a group of stock

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30
Q

What is payoff for long forward

A

Spot Price @ expiration - Forward Price

31
Q

What is payoff for short forward

A

Forward Price - Spot Price @ expiration

32
Q

What is a call option

A
  • Non-binding agreement to buy asset in future at a price set today
  • At expiration buyer can decide to exercise or stop on the
33
Q

What do you buy and sell in Arbitrage

A

Sell expensive, buy cheap

34
Q

Advantage and Disadvantage to Call Option

A

+: preserves upside potential while eliminating the the downside for buyer
-: comes at a premium

35
Q

What is Strike Price

A

The amount paid by the option buyer if he/she decides to exercise the call option at expiration

36
Q

What are the 3 exercise options

A
  1. European Style: exercise only at expiration
  2. American Style: exercise any time before expiration
  3. Bermudan Style: exercise during specified period
37
Q

Call Option Payoff

A

Max[0, St - K]
St = Spot Price
K = Strike Price

38
Q

Call Option Profit

A

Max[0, St - K] - FV(premium)

39
Q

Option Writer

A

The seller who receives the premium but has the obligation to sell at the strike price if the buyer chooses to exercise the option

40
Q

Written Call Payoff

A

Max[0, St - K]

41
Q

Written Call Profit

A

Max[0, St - K] + FV(premium)

42
Q

What is a Put Option

A
  • opposite of call option
  • seller has the right to sell at strike price but not obligated
  • seller can choose to sell at the strike price or choose to keep the asset
43
Q

Put Option Payoff

A

Max[0, K - St]

44
Q

Put Option Profit

A

Max[0, K - St] - FV(premium)

45
Q

Call/Put Profitability

A

Call: more profitable when the asset increases in value
Put: more profitable when the asset decreases in value

46
Q

In-The-Money Option

A

Call: Strike < St
Put: Strike > St

47
Q

Out-The-Money Option

A

Call: Strike > St
Put: Strike < St

48
Q

Written Call

A

obligation to sell asset at strike price if option exercised

49
Q

Written Put

A

obligation to buy asset at strike price if option exercised

50
Q

What does it mean to Hedge an Investment

A

Hedging is like insurance against something bad happening to minimize loss.
Ex. buying house insurance is like hedging against fires, floods, break-ins

51
Q

What is Put Call Parity

A

C(k) - P(k) = PV(F) - PV(k)
or
C(k) - P(k) = So - ke^(-rt)
Call Premium - Put Premium = Stock - Bond

52
Q

What is Synthetic Forward

A

This is when you buy a call and sell a put or vice-versa. This in return creates a forward when combined because no matter what you will end up buying an asset at the strike price.

53
Q

Differences between forward and synthetic forward

A
  1. ) Forwards do not have premiums however with Synthetic Forward you must pay the net option premium
  2. ) Forward contract you pay Forward price, Synthetic Forward you pay the strike price
54
Q

Synthetic Call

A

C = P + S - ke^(-rt)
Long Put
Long Stock
Short Bond

55
Q

Synthetic Put

A

P = C - S + ke^(-rt)
Long Call
Short Stock
Long Bond

56
Q

Synthetic Stock

A

S = C - P + ke^(-rt)
Long Call
Short Put
Long Bond

57
Q

Synthetic Bond

A

ke^(-rt) = P + S - C
Long Put
Long Stock
Short Call

58
Q

What is a Floor

A

The purchase of a put on a long forward means you’re insuring the long position in an asset. It guarantee’s a minimum sale price.

59
Q

What is a Cap

A

The purchase of a call on a short forward is called a cap. This is you insuring the short position. It caps the amount lost.

60
Q

What is covered writing

A

writing an option when there is a corresponding long position in the asset

61
Q

What is naked writing

A

the writer of the option has no position in the asset

62
Q

What is covered call writing

A

This is when you take the long position in an asset and write a call

63
Q

What is covered put

A

Achieved by writing a put against a short position on the index. Same as writing a call.

64
Q

What is a spread

A

Position consisting of only call and put, some are purchased and some are written

65
Q

What is Bull Spread

A

Long Forward with upside limit and downside protection
Buy: C(k1) or P(k1)
Sell: C(k2) or P(k2)
k1 < k2

66
Q

What is Bear Spread

A 
Short Forward with upside limit and downside protection
Buy: C(k1) or P(k1)
Sell: C(k2) or P(k2)
k1 > k2
**OPPOSITE BULL SPREAD**
67
Q

What is Box Spread

A

This is combination of bull spread and bear spread, resulting in a risk free bond
Buy: +C(k) and -C(x)
Sell: +P(x) and -P(k)
HORIZONTAL LINE ON AXIS

68
Q

What is Ratio Spread

A

Buy: nC(k1) or nP(k1)
Sell: mC(k2) or mP(k2)
n < m, k1 < k2
AS ‘m’ INCREASES, SLOPE INCREASES

69
Q

What are Collars

A

Resembles a short forward contract as the benefit is if the asset price decreases
Buy: P(k1) or C(k1)
Sell: C(k2) or P(k2)
k1 < k2

70
Q

What is a Collared Stock

A

This looks like a bull spread and a written collared stock looks like a bear spread

71
Q

What is a Straddle

A

This is buying a call and put with same strike and expiration date. Make money off volatility!

  • stock rises, profit on call
  • stock falls, profit on put
  • high premiums
  • if stock nears strike price, loss on both ends
  • *V-SHAPE**
72
Q

What is a written straddle

A

This you are betting on minimal volatility hoping the price doesn’t change much. SELLING STRADDLE

73
Q

What is a Strangle

A 
Cheaper version of a straddle but still trying to make money off volatility.
Buy: P(k1)
Sell: C(k2)
k1 > k2
**U-SHAPE**
74
Q

What is a Butterfly Spread

A

Combination of a short straddle and a long strangle. Used for speculating little volatility hedge a written straddle.
- limits downside loss

FM 2557 (2 decks)

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