Extra Important Cards Flashcards
If put call parity violated, how can we exploit
Execute a synthetic long position by simultaneously buying puts and selling calls. Then reap the immediate profit.
What separates currency swaps from interest rate swaps (2)
B) Currency swaps require the exchange of notional amounts at the end of the swap.
C) Currency swaps have to satisfy Covered Interest Rate Parity.
Why does a butterfly spread benefit the most from a decrease in volatility?
A decrease in volatility would result in lower option premiums across all strikes involved in the butterfly spread.
Benefit from Reduced Premiums: Since the butterfly spread involves both buying and selling options, a decrease in volatility benefits the strategy by reducing the cost of buying options while potentially increasing the credit received from selling options
If it asks why something is positive - like an option like vega?
volatility is valued (in a partial derivative sense) as it increases potential upside without harming downside.
Consider a CDS Index consisting of several CDS, each of which has a probability of default of 5%. What are the preferences of holders of different tranches (senior, mezzanine, junior, equity) with respect to underlying default correlation? Why?
Senior tranches prefer low correlation, as that would reduce the probability of many CDS triggering at the same time, which would hurt senior values. Junior tranches prefer high correlation, as that reduces the percentage of the time they are hurt.
How are debt contracts similar to short put options? Who is long that put?
Limited liability is a put option on the assets of the company with a strike equal to the face value of debt. Debt holders are therefore short that put option.
Give a reason that the corporate bond yield of a company could increase while CDS spreads on the same company remain unchanged.
recession - higher prob of defaulting - so higher yield needed to compensate
Volatility smile meaning
volatility smile typically refers specifically to an upward-sloping skew, where options with lower strikes have higher implied volatilities, resembling a smile shape
