Part 1 - Derivs Basics

Question 1

What is derivative

Answer 1

A derivative is a financial instrument whose value is determined by other prices.

Question 2

why is derivates pricing important (3)

Answer 2

More sophisticated hedging, better risk management and more targeted speculation

Question 3

spot transaction meaning

Answer 3

Exchange money for a commodity, stock, bond. Buyer holds on to it and seller may invest with cash

Question 4

forward transaction meaning

Answer 4

buyer holds cash for now - seller holds what they have - future date they exchange

Question 5

what must forward contract include (3)

Answer 5

Quantity (and type) of underlying asset
Time and place of delivery.
Type of settlement: physical delivery or cash settlement.

Question 6

trading strategy of buyer of forward and seller of forward

Answer 6

Buyer of forward is long, seller is short

Question 7

Why do we hedge (3)

Answer 7

price, ER and interest rate volatility

Question 8

Why did crypto peak in 2017?

Answer 8

Late 2017 at the peak - lot of speculative betting against the value of Bitcoin, so that would make it crash. In spot market price was higher than in the futures market. People opted for futures market because people were selling futures prices less than spot prices, spot market demand for crypto goes down, price of crypto in sport market decreases

Question 9

What is portfolio insurance?

Answer 9

Suppose you hold a position in underlying S.
When S declines, sell futures F.
Offset losses today.
Future cashflows are hedged.
When S increases, can buy F or not.