Chapter 6, Derivatives

Question 1

What is a derivative?

Answer 1

Financial instrument who’s price is based off of something else (typically an underlying asset - bond, share, commodity (oil, silver, gold))

Question 2

What forms do derivatives come in?

Answer 2

• Forwards
• Futures
• Options

Question 3

What ways are derivatives used?

Answer 3

• Hedging
• Speculation

Question 4

What is hedging?

Answer 4

Replacing uncertainty with certainty, agreeing a price in advance so it is not impacted by changing market prices

Question 5

What is speculation?

Answer 5

Using derivatives to make money, anticipating a price increase, buying before and selling when the price is high

Question 6

What are futures?

Answer 6

Used to hedge - replaces uncertainty with certainty about prices, used for speculation - trying to make money by anticipating change later
- Exchange-traded
- Dealt on standardised terms - exchange specifics quality of underlying asset, quantity underlying each contract

Question 7

What is an option?

Answer 7

A derivative that gives the buyer the right, but not the obligation, to buy/sell a specified quantity of assets at a pre-agreed price

Question 8

What are the 2 option classes?

Answer 8

• Call option
• Put option

Question 9

What is a call option?

Answer 9

When the buyer has the right to buy the asset at the exercise price - seller is obliged to deliver

Question 10

What is a put option?

Answer 10

When the buyer has the right to sell the underlying asset at the exercise price - seller is obliged to deliver

Question 11

What is the premium?

Answer 11

Money paid by the buyer to the seller at the beginning of the options contract; non-refundable