wk4

Question 1

why are derivatives important?

Answer 1

-risk management

Question 2

what must a competent asset manager do?

Answer 2

-recognise and understand risk
-protect against risk known as hedging
-exploit risk known as speculation
evaluate results after allowing for risk

Question 3

define heding

Answer 3

invest to reduce risk from movements in asset price
-borrower & lender concern = interest rate changes
-commodity producers and buyers concern = price changes
-importers and exporters concern = exchange rate change
a way of hedging is forming diversified portfolio of asset to reduce risk or enter derivates contract premium paid and or profit foregone

Question 4

define speculation

Answer 4

earn profit for accepting risk or understand potential for gains
-hedgers pay speculators for taking on risk

Question 5

define arbitrage

Answer 5

-earn riskless, costless profit by trading

Question 6

define leverage (gearing)

Answer 6

borrow to increase potential return on investment
trader increase risk and return by leverage

Question 7

What are the two types of ways derivates are traded?

Answer 7

• exchange traded contracts = organised exchange, know parties, guarantees contract
• over the counter = corporate treasures contact each other to negotiate and agree terms contract traded directly between two parties each taking on credit of other

Question 8

what are derivate instruments?

Answer 8

• contracts derive value from value or return of underlying asset

Question 9

what are the key contracts of derivate instruments?

Answer 9

-forwards and futures
-options
-swaps
these are the key contracts

Question 10

what were derivative contracts originally written on?

Answer 10

commodity prices but now can buy contracts from equity prices, bond prices and interest rates

Question 11

short position

Answer 11

to sell

Question 12

long position

Answer 12

to buy

Question 13

forwards and futures

Answer 13

contract to buy or sell asset in future at certain price and time

Question 15

options

Answer 15

holder rights to buy or sell asset at certain price

Question 16

swaps

Answer 16

agreement to exchange cashflow at certain prices and times

Question 17

what is an underlying asset

Answer 17

what type of as is it so for example a stock price or exchange rate

Question 18

what is a derivative type?

Answer 18

what type of contract is so forward, future swap or option

Question 19

how can risk be reduced

Answer 19

• insurance
  -diversification
  -match duration of asset and liabilities
  futures, forwards, options and swaps

Question 20

why are derivatives used?

Answer 20

-to hedge risks
-change nature of liability
-speculate so take view on future direction of market
-change nature of investment

Question 21

forward contracts

Answer 21

agreement to trade specified asset at specified future time an place at agreed price

Question 22

what are the basic types of forward contracts

Answer 22

foreign exchange, commodity, FRA

Question 23

what two parties can forward contracts be created with?

Answer 23

long position = agree to sell in future, expect price to increase in future
short position = agree t sell in future, expect price to decrease