Chapter 3 In Class Notes

Question 1

Define Derivative

Answer 1

Financial contract that derives its value from an underlying asset, bond, stock, currency, commodity, index, interest rate - Libor, etc

Question 2

What is the purpose of a derivative

Answer 2

control risk, mitigate or eliminate risk

Question 3

Types of derivatives

Answer 3

Forward, Futures, options

Question 4

Counterparties of derivatives

Answer 4

2 parties to the contract. long = buyer, short = seller

Question 5

Characteristics of derivatives

Answer 5

flexible, negotiable, final investments

Question 6

Long agrees to buy asset from the short @ a future date for a pre-determined price. What is this called.

Answer 6

Forward

Question 7

Trades or exchange, standardized. What is it called

Answer 7

Futures

Question 8

Two kinds of options.

Answer 8

Call & Put

Question 9

Call

Answer 9

The right to buy the asset from the short in the future at x (exercise price or strike price)

Question 10

Put

Answer 10

The right to sell the asset in the future at the x( exercise price or strike price)

Question 11

Interest Rate Swap

Answer 11

Allows you to have a fixed interest rate. When you have a floating rate you can swap with a swap person. You have them pay you the floating rate and you pay them the fixed rate.

Question 12

Currency swap

Answer 12

Where you swap one currency for another. You can change the nature of an obligation with a swap

Question 13

Credit Default swap

Answer 13

an insurance contract that is triggered by default.

Question 14

Currency Forward

Answer 14

Exchange one currency for another in the future at a predetermined price.
Short deliver base currency. Long pays in terms currency. Settles & maturity. Risk & Default. Between 2 private parties. Customized. smaller size,

Question 15

Future Pricing

Answer 15

LIBOR convention

Question 16

Right to sell base currency
@ X‑exercise price in terms
currency

Answer 16

long put

Question 17

right to purchase base
currency @ X=exercise
price in terms currency.

Answer 17

Long Call

Question 18

Exercise only @ maturity

Answer 18

European Option

Question 19

Exercise anytime up to maturity

Answer 19

american option

Question 20

wasting asset. Price declining with time

Answer 20

Option Value

Question 21

Profit on put or call =

Answer 21

Payoff +‑ premium

Question 22

Price of currency at

maturity

Answer 22

S (strike price)

Question 23

C

Answer 23

amount of the call premium

you pay up front

Question 24

P

Answer 24

amount of the put premium

you pay up front

Question 25

Intrinsic value of the put

option

Answer 25

X-S

Question 26

Intrinsic value of the call option

Answer 26

S-X

Question 27

How they value options prior to maturity

Answer 27

S = Price of currency
X = Strike Price
T= time
0 = volatility
r= domestic int rate
r* foreign int rate

Question 28

Any currency that trades

outside its borders is called

Answer 28

Eurodollar, eurocurrency,

Question 29

Widely traded contract in

world

Answer 29

Euro $ Futures (USD 1

Million)

Question 30

Profit of Euro currency =

Answer 30

((100‑f)/100) ‑ LIBOR) *

90/360 * 1,000,000

Question 31

On a long gain if LIBOR goes down

Answer 31

Rates go down and prices go up