Types of Derivative

Question 1

What is a future?

Answer 1

Exchange traded binding agreement to exchange:
- Specified Asset
- Specified Quantity
- at a Specified Price
- On a fixed date

Question 2

What is standardized in an exchange traded contract?

Answer 2

1) Size (e.g. x barrels of oil)
2) Quality
3) Type of asset
4) Experiation Date
5) Delivery Date

Question 3

What are the specified delivery months on CBOT?

Answer 3

1) March
2) May
3) July
4) September
5) December

Question 4

What does fungible mean?

in regards to futures

Answer 4

substitutable with (identical)

Question 5

What is a STIR future?

Answer 5

Short Term Interest Rate Future
3 month interest rate contracts
all major FXs

Question 6

What is a long term future?

Answer 6

5, 10 and 30 year Govt bonds

(the most recent issue in each case)

Particuarly the 10 yr bond of any country

Question 7

What is the difference between a future and a forward

Answer 7

1) Future exchange traded
2) Forward OTC

Question 8

What are the advantages of forwards

Answer 8

1) Bespoke (grade, size, date etc)
2) Wide range of assets
3) available from most commercial banks

Question 9

What are the disadvantages of forwards?

Answer 9

1) Less liquidity
2) Counterparty risk

Question 10

What is novation, what does it do?

Answer 10

the CCP becomes the counterparty to both the original buyer and seller of the contract and guarantees contractual fulfillment if either party defaults.

Reduces counterparty / credit risk

Question 11

Where are forwards most commonly used and why?

Answer 11

FX markets - to hedge risk

Question 12

What are the four styles options come in?

Answer 12

1) American
2) European
3) Asian
4) Bermudan

Question 13

When can these options be exercised
1) American
2) European
3) Bermudan

Answer 13

1) Anytime up to expiry
2) On expiry
3) On specified dates before expiry and on expiry (usually once a month)

Bermudan is a half way house between American and European

Question 14

Why do American style options carry a greater premium?

Answer 14

The addex flexibility

For example being able to exercise early to receive a dividend.

Question 15

What does the premium of an option consist of?

Answer 15

It is the price of the option

Intrinsic and Time Value

Question 16

What is the spot price?

Answer 16

The available cash price of the asset in the market

Question 17

What is the intrinsic value of an option?

Answer 17

The immediately realiseable profit on an option.

Intrinsic value cannot be less than zero.

Intrinsic = 0 = at the money & >0 = in the money

Question 18

What is the time value of an option?

Answer 18

The time value of an option is the premium less the intrinsic value

It is calucated by considering the volatility of the underlying. And it diminishes as it approaches expiry.

Question 19

When are call and put options in the money?

Answer 19

Call = Spot > Strike (can pay less than what its worth)

Put = Strike > Spot (Can buy it @ spot and then sell it for more than it is worth)

Question 20

What is the loss on a long call or put limited to?

Answer 20

The premium paid