Chap 10 : Derivatives

Question 1

A financial contract between two parties whose value is derived from, or dependent on, the value of an underlying asset.

Answer 1

Derivative

Question 2

With _________ contracts, both parties oblige themselves to trade the underlying asset in the future at a price agreed upon today.

Answer 2

Forward

Question 3

With _______, no upfront payment is required.

Answer 3

Forwards

Question 4

A payment which gives the party on the other side of the transaction a higher level of assurance that the terms of the forward will be honoured.

Answer 4

Performance bond or good-faith deposit

Question 5

With ______, the buyer makes a payment to the seller when the contract is drawn up. This payment, known as the premium, gives the buyer the right to buy or sell the underlying asset at a pre-set price on or before the expiration date.

Answer 5

Options

Question 6

Another feature of derivatives is that, unlike financial assets such as stocks and bonds, they are considered ___________. the gain from an option or forward contract by one counterparty is exactly offset by the loss to the other counterparty. In other words, every dollar gained by one party represents a dollar lost by the counterparty.

Answer 6

zero-sum game

Question 7

Most bonds trade in the _________ market

Answer 7

over-the-counter

Question 8

Stocks and derivatives trade both on the _________ market and in __________

Answer 8

OTC

Organized exchanges

Question 9

One of the attractive features of OTC derivatives to the corporations and institutional investors that use them is that contracts can be …………..

Answer 9

custom designed to meet specific needs

Question 10

The derivatives exchange

Answer 10

Montreal Exchange

Question 11

Another downside to the private nature of OTC derivatives is that __________ (also know as credit risk) is a major concern

Answer 11

default risk

Question 12

____________, which are set up by exchanges to ensure that markets operate efficiently, guarantee the financial obligations of every party and contract.

Answer 12

Clearinghouses

Question 13

The ___________ is responsible for clearing Montreal Exchange futures and option trades.

Answer 13

Canadian Derivatives Clearing Corporation

Question 14

derivative transactions on exchanges are extensively regulated by ___________

Answer 14

the exchanges themselves and by gov’t agencies

Question 15

OTC derivative transactions are…….

Answer 15

generally unregulated

Question 16

Gains and losses accrue on a day-to-day basis is known as _______

Answer 16

Marking to Market

Question 17

The two general categories of underlying assets for derivative contracts are _______- and _______.

Answer 17

Commodities and Financial Assets

Question 18

___________ and options are commonly used by producers, merchandisers, and processors of commodities to protect themselves against fluctuating commodity prices.

Answer 18

Commodity Futures

Question 19

A __________ opportunity refers to a scenario where the same asset or commodity is traded at different prices in two separate markets. By purchasing low in one market and selling high in the other market simultaneously, an investor locks in a fixed amount of profit at no risk

Answer 19

Arbitrage

Question 20

_____________ is a method of boosting returns on an underlying investment portfolio by taking a speculative position based on expectations of future market movements. The most popular way to enhance an investment’s yield is by selling options against the position.

Answer 20

Yield Enhancement

Question 21

An option that gives its holder the right to buy, and the seller the obligation to sell, the underlying asset is known as a _________

Answer 21

Call Option

Question 22

An option that gives the holder the right to sell, and its writer the obligation to buy, the underlying asset is referred to as a _________

Answer 22

Put Option

Question 23

_______________is the price at which the underlying asset can be purchased or sold in the future. The buyer and the seller agree on this future price when they enter into the option contract

Answer 23

The Strike price or Exercise Price

Question 24

To obtain the right to buy or sell the underlying asset, option buyers must pay the sellers a fee, known as the ………

Answer 24

option premium

Question 25

___________ style options can be exercised at any time, up to and including the expiration date.

Answer 25

American

Question 26

_______style options can be exercised only on the expiration date.

Answer 26

European

Question 27

A ________________ is simply a long-term option contract offering the same risks and rewards as a regular option

Answer 27

Long-term equity anticipation security

Question 28

A ___________ transaction occurs when an investor establishes a new positon in an option contract.

Answer 28

Opening

Question 29

Positions may be liquidated prior to expiration by way of an........

Answer 29

offsetting transaction

Question 30

The party of the long position will exercise the option. When this happens, the party holding the short position is said to be _______ on the option

Answer 30

Assigned

Question 31

Owners of options will exercise only if it is in their best financial interest, which can only occur when an option is ____________

Answer 31

in-the-money

Question 32

Owners of options will not exercise if they are __________-

Answer 32

out of the money or at the money

Question 33

___________ is the value of certainty

Answer 33

Intrinsic Value

Question 34

If an option is not in-the-money, it has ___________ value

Answer 34

zero intrinsic value

Question 35

__________ are bought to establish a maximum purchase price for the stock, or to limit the potential losses on a short position in the stock. In this sense, options act much like insurance by protecting the buyer when the stock price moves higher

Answer 35

Call options

Question 36

___________ writers own the underlying stock, and use this position to meet their obligations, if they are assigned.

Answer 36

Covered Call

Question 37

_________writers do not own the underlying stock

Answer 37

Naked Call

Question 38

When a forward is traded on an exchange, it is called a _____________

Answer 38

Futures Contract

Question 39

_______ can trade on an exchange or OTC markets

Answer 39

Forwards

Question 40

When a forward is traded OTC, it is generally referred to as a........

Answer 40

Forward Agreement

Question 41

Many financial futures are based on underlying assets that are difficult or even impossible to deliver. For those types of futures, delivery involves an exchange of cash from one party to the other. The amount is based on the performance of the underlying asset from the time the future was entered into until the time that it expires. These futures are known as _________

Answer 41

Cash Settled Futures Contracts

Question 42

Like call options, ______ and _______ are securities that give their owners the rights, but not the obligation, to buy a specific amount of stock at a specified price on or before the expiration date.

Answer 42

Rights and Warrants

Question 43

Rights and Warrants are usually issued by a ______ as a method of raising capital.

Answer 43

Company

Question 44

_____ are usually short term, with the expiration date often as little as four to six weeks after they are issued

Answer 44

Rights

Question 45

______ tend to be issued with three to five years to expiration

Answer 45

Warrants

Question 46

A _______ is a privilege granted to an existing shareholder to acquire additional shares directly from the issuing company.

Answer 46

Right

Question 47

The exercise price of a right, known as the ______ price or ________ price, is the price shareholders pay to purchase additional shares of the company. The offering price is almost always lower than the market price of the shares at the time that their rights are issued. This discount makes the rights valuable and gives shareholders an incentive to exercise them.

Answer 47

Subscription or Offering price

Question 48

As with options, the trading price of a right is equal to the ____________, if any, plus the time value.

Answer 48

Intrinsic Value

Question 49

You have to add +1 to the denominator of the Intrinsic Value of Rights equation during the __________ period, when the rights are imbedded in the common stock.

Answer 49

Cum Rights

Question 50

A ________ is a security that gives its holders the right to buy shares in a company from the issuer at a set price by a set period of time

Answer 50

Warrant

Question 51

Warrants are like call options. The main difference is........

Answer 51

Warrants are issued by the company itself, whereas call options are issued by other investors.

Question 52

Warrants are often issued as part of a package that also contains a new debt or preferred share issue. The warrants help make these issues more attractive to buyers by giving them the opportunity to participate in any appreciation of the issuer's common shares. In other words, they function like, and are known, as a _________.

Answer 52

Sweetener

Question 53

The predominant type of Forward Agreements are based on _______ and _______

Answer 53

Interest Rates and Currencies

Question 54

If the put writer had set aside an amount of cash equal to the purchase value of the stock if assigned, the strategy is known as a.....

Answer 54

cash-secured put write