Risk Management Flashcards
What are futures?
Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash.
What is a forward/forward or forward agreement?
An arrangement between two instutitions to lend or borrow a set amount at a set rate for a set period which will not begin for some months.
What is a forward rate agreement?
Forward rate agreements (FRAs) establish interest rates for borrowers, for lendgers or for a set period in advance. When that period is set to begin the parties settle the difference between the prevailing level of interest rates and the rate agreed under the FRA. This prevents the problem with forward agreements which involve the actual borrowing of a sum.
What is an interest rate swap?
The basic concept is that two borrowers raise money separately and then agree to service each other’s interest payments. However, many swap deals are far more complicated and can involve several currencies and half a dozen borrowers, with only the bank in the middle aware of all the details.
This may occur for two main reasons:
- Different perceptions of different markets (ie some lenders may be more inclined to lend to certain countries or corporations)
- They allow borrowers to manage existing debt by swapping between fixed and floating interest rates or from one currency to another
What are credit default swaps?
This is like an insurance policy against a default. One party pays a premium to another; in return, the seller agrees to pay up if the borrower defaults. The higher the premium, the riskier the company.
