Options Markets and Swaps

Question 1

What is the benefit and drawback of futures?

Answer 1

1. Futures can completely insulate a firm against price changes
2. Can also eliminate gains if the price moves favourably

Question 2

What is an option and how is it valued?

Answer 2

A contract where person B gives a right to A.

Valued at the price of the option + the price to fulfil (car worth 1,000, option to buy the car for 500, so the option is prices at 500)

Question 3

Define a call and a put

Answer 3

Calls: Give the holder the right to BUY the underlying asset
Puts: Give the holder the right to SELL the underlying asset

Question 4

What is an American Option and European Option

Answer 4

American: Redeemable at any time before or at the expiry date
European: Redeemable only at the expiry date

Question 5

Define Swaps

Answer 5

The exchange of payment obligations on two financial liabilities where principle amounts are the same but payment patterns are different

Question 6

Define Interest Rate Swaps. Are they Fixed or Floating

Answer 6

Forward contracts where one stream of future interest payments are exchanged for another based on a specific principle.

Can be fixed or floating

Question 7

Define Credit Default Swaps

Answer 7

Insurance premiums for if some people do not pay their bonds.