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Old CFA A Most Important Concepts per Study Session > Study Session 17 - Derivative Investments > Flashcards

Study Session 17 - Derivative Investments Flashcards

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CFA flashcards
1
Q

What does a fiduciary call portfolio consist of?

A
  • A long position in a European call option
  • A long position in a pure-discount riskless bond

**gets its name because it is faithful to the notion of preserving capital**

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2
Q

What does a protective put portfolio consist of?

A
  • A long position in a European put option
  • A long position in the underlying stock
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3
Q

What is the formula for put-call parity for European options?

A
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4
Q

What is the general formula used to solve any “synthetic” options?

A
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5
Q

What are the steps to creating a synthetic European call option ?

A
  • Buy a European put option on the same stock with the same exercise price (X) and the same maturity (T)
  • Buying the stock
  • Short the present value of X worth of a pure-discount riskless bond
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6
Q

What are the steps to creating a synthetic European put option ?

A
  • Buying a European call option
  • Shorting the stock
  • Buying (i.e. investing in) the pure-discount riskless bond
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7
Q

What are the steps to creating a synthetic stock position ?

A
  • Buy a European call option
  • Short (i.e. writing) a European put option
  • Buying ( i.e. investing in) the pure-discount riskless bond
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8
Q

What are the steps to creating a synthetic pure-discount riskless bond ?

A
  • Buying a European put option
  • Buying the stock
  • Shorting (i.e. writing) a European call option
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9
Q

What is the equation we use to calulate the the size of the Up (U) or Down (D) of the possible price changes in a binomial option model?

A

Either the U or D will be given. The equation to solve for the other is:

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10
Q

How do you calculate the risk-neutral probability of an up-move or down-move binomial option model?

A
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11
Q

How is an option’s delta calculated?

A
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12
Q

How do you calculate the expiration value of a caplet of European style options???

A
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13
Q

How do you calculate the expiration value of a floorlet of European style options???

A
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14
Q

What are the 5 inputs to the BSM model?

A
  1. Asset price (Delta)
  2. Exercise price
  3. Asset price volatility (Vega)
  4. Time to expiration (Theta)
  5. The risk-free rate (Rho)
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15
Q

What does Delta measure?

A

It describes the relationship between asset price and option price.

* A call option’s delta is positive b/c as the underlying prices increases, so does the call options value

* A put option’s delta is negative b/c the put value falls as the asset price increases.

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16
Q

What does Vega measure?

A

It measures the sensitivity of the option price to changes in the volatility of returns on the underlying asset.

***Since calls and puts are more valuable the higher the volatility, vega is positive for puts and calls.

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17
Q

What does **Rho **measure?

A

It measures the sensitivity of the option price to changes in the risk free rate.

**Call option is positive

***Put option is negative

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18
Q

What does Theta measure?

A

It measures the sensitivity of the option price to the passage of time.

As time passes and a call option approaches maturity, its value declines, all else equal. aka “time decay”

19
Q

What does Gamma measure?

A

How well the delta sensitivity measure will approximate the option price’s response to a change in the price of the underlying.

**Is larger when there is more uncertainty about whether the option will expire in or out of the money. This means gamma will tend to be large when the option is at-the-money and close to expiration

20
Q

What is the formula to calculate the # of options needed to delta hedge?

A
21
Q

What is a plain vanilla swap?

A

A fixed to floating interest rate swap.

22
Q

What is a swaption?

A

An option that gives the holder the right to enter into an interest rate swap.

23
Q

What is a payer swaption?

A

The right to enter into a specific swap at some date in the future as the fixed-rate payer at a rate specified in the swaption

24
Q

What is a receiver swaption?

A

The right to enter into a specific swap at some date in the future as the fixed-rate receiver at the rate specified in the swaption.

25
Q

What are the 3 primary uses of swaptions?

A
  1. Lock in fixed rate
  2. Interest rate speculation
  3. Swap termination
26
Q

Describe the degree of credit risk in a swap during the life of the swap (i.e. beginning, middle and end) …..

A

Beginning: Low

Middle: Highest

End: since few payments are left, credit risk is low again.

27
Q

What is a swap spread?

A

The spread betwen the swap rate and the comparable maturity Treasury note

28
Q

What is an interest rate cap?

A

An agreement in which one party agrees to pay the other at regular intervals over a certain period of time when the benchmark interest rate exceeds the strike rate specified in the contract.

29
Q

The buyer of a cap is similar to that of a _______?

A

The buyer of a call option

** this is b/c the buyer only gets paid if rates rise and exceed the cap strike.

30
Q

What is an interest rate floor?

A

An agreement in which one party agrees to pay the other at regular intervals over a certain time period when the benchmark interest rate falls below the strike rate in the contract.

31
Q

The buyer of a interest rate floor has a position similar to ________?

A

The buyer of a put on LIBOR.

***benefits when interest rates fall below the strike price.

32
Q

What is the formula to calculate the payoff to a floating rate cap buyer?

A
33
Q

What is the formula to calculate the payoff to the floor buyer?

A
34
Q

In simple terms, what is a credit default swap?

A

An insurance contract. If a credit event occurs, the credit protection buyer gets compensated by the credit protection seller.

35
Q

What are the common types of credit events specified in CDS agreements?

A
  1. Bankruptcy
  2. Failure to pay
  3. Restructuring
36
Q

What are the 3 factors that influence the pricing of a CDS?

A
  1. Probability of defaul
  2. Loss given default
  3. The coupon rate on the swap
37
Q

Define what the Probability of Default is …..

A

The likelihood of default by the reference entity in a given year.

38
Q

What is the** hazard rate** ?

A

The probability of default given that it has not already occured.

39
Q

Consider a 5 yr CDS on ABC corp. ABC’s hazard rate is 2% and increases 1% a year.

Compute the survival rate after 5 years…

A

Hazard rates are: 2%, 3%, 4%, 5%, 6%

Surival rate in 5 years = (1-0.02)(1-0.03)(1-0.04)(1-0.05)(1-0.06) = 0.815 = 81.5%

40
Q

Define what **Loss given default **is ….

A

The expected amount of loss in the event that a default occurs.

** Is inversely related to the recovery rate

expected loss = hazard rate * loss given default

41
Q

What is the premium leg ?

A

the payments made by the protection buyer to seller

42
Q

What is the protection leg ?

A

when the protection seller must make a payment to the protection buyer in case of a default.

43
Q

How do you calculate the upfront premium % of a CDS ?

A

** This is paid by the protection buyer.

= (CDS Spread - CDS Coupon) * duration of CDS

Old CFA A Most Important Concepts per Study Session (6 decks)

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