Mod 19 Derivative Key Terms Flashcards
Bifurcation
Process of separating embedded derivative from its host
Contract
At the money
Option where the price of underlying is equal to strike or exercise
Price
Purpose of bifurcation
Separate financial instruments into different components to
Account and valuate appropriately
Derivative instruments are financial instruments or other contracts that have…3 (characteristics)
1 one or more underlyings and notational amounts
2 no initial net investment or smaller net investment than required
Contracts expected to have similar market responses
3 terms that require or permit net settlement
Derivative instruments: terms that require or permit…3
1 net settlement
2 net settlement by outside contract
3 delivery of asset that results in position substantially the same
As net settlement
Discount or premium on a forward contract
Foreign currency amount of contract
multiplied by the difference Between the contracted forward rate
and spot rate at date of inception of contract
Embedded derivative
Feature on financial instrument or contract,
if stood alone would meet definition of derivative
Firm commitment
Agreement with unrelated party, binding both using legally
enforceable, specifying all terms
Includes disincentive for nonperformance, making performance
Likely
Financial instruments include…
Cash, A/R, A/P, bonds, common stock, preferred stock,
Stock options, foreign currency forward contracts, futures
Contracts
Forecasted transaction
Transaction expected to occur where there is no firm commitment
Gives entity no present rights or obligations
Forecasted transactions can be…
Hedged (special hedge accounting can be applied)
3 ways foreign currency transactions arise
1 buy and sell credit goods/services in foreign currency
2 borrow or lend in foreign currency
3 party to unperformed forward exchange contract
Forward contract, an agreement between 2 parties to…
Buy and sell specific commodity, foreign currency, or financial
Instrument at agreed upon price
With delivery and settlement at designated future
A forward contract is…
2) what does this mean?
Not formally regulated by an organized exchange
2) each party to contract is subject to default of other party
Forward exchange contract
Agreement to exchange at specified future date currencies of
Different countries at specified rate
Forward rate
Specified rate
Futures contract
Forward based contract to make or take delivery of designated
Financial instrument, foreign currency or commodity
During designated period at specified price or yield
Futures contract frequently has provisions for…
Cash settlement
Futures contract is traded on…
2) what does this mean?
A regulated exchange
2) involves less credit risk than forward contract