Derivatives

Question 1

What is a derivative?

Answer 1

Question 2

Derivatives being a contingency or commitment means what and how do derivatives expand market opportunities?

Answer 2

Question 3

What are the types of underlying assets?

Answer 3

Credit - CDS ➞ Credit Default Swap
long CDS = short credit quality i.e. long the spread, benefit if spread ↑
short CDS = long credit quality i.e. short the spread, benefit if spread ↓
Other - weather, cryptocurrencies

Question 4

Derivatives asset class and examples

Answer 4

Question 5

Types of derivative markets: OTC, exchange-traded and central clearing

Answer 5

Question 6

What are the four features of a commitment and what is a forward contract

Answer 6

Question 7

What is a futures contract?

Answer 7

Question 8

Explain what a swap contract is?

Answer 8

Question 9

What is a contingent claim?

Answer 9

Question 10

What are the payoff diagrams for being long/short a put/call

Answer 10

Question 11

What are credit derivatives?

Answer 11

Question 12

What happens in a credit default swap?

Answer 12

Question 13

Benefits of derivatives: risk allocation, transfer , managment

Answer 13

Question 14

Benefits of derivatives: information discovery and operational advantages and market efficiency

Answer 14

4/ Market efficiency - less costly for arbitrage

Question 15

Risks of derivatives: Greater speculation potential, lack of transparency, basis risk, liquidity risk

Answer 15

Question 16

Risks of derivatives: Counterparty credit risk and destabilisation and systematic risk

Answer 16

4/ Counterparty credit risk - lower with ETD (esp. with price limits)
OTC - commitments - both sides have this risk
- contingencies - only the long side has this risk

5/ Destabilization and systemic risk - excessive risk taking and leverage
can create market stress when equity depletes and
credit for margin calls dries up

Question 17

What do issuers primarily hedge and is a cash flow and fair value hedge

Answer 17

Question 18

What is the net investment hedge and what are the uses of derivatives for issuers and investors

Answer 18

Question 19

What is the concept of arbitrage?

Answer 19

Question 20

What is the concept of replication?

Answer 20

Question 21

What is the cost of carry?

Answer 21

Question 22

What is a forex foward

Answer 22

Question 23

What is a commodity derivative and convenience yield?

Answer 23

Question 24

What is the value of a foward contract at T=0, t and T

Answer 24

Question 25

Payoff for a forex foward

Answer 25

Question 26

The payoff for a interest rate forward contract

Answer 26

Question 27

Compare and contrast forwards and futures

Answer 27

Question 28

What causes the differences in valuation between forwards and futures, and when would they be identical

Answer 28

Question 29

Explain the long/short positions for interest rate futures

Answer 29

Question 30

Interest forwards vs futures strategy for hedging

Answer 30

Question 31

Explain the difference in central clearing method of futures vs forwards

Answer 31

Question 32

Explain the difference between FRA's and swaps

Answer 32

Question 33

Formula for the fixed rate in an interest rate swap

Answer 33

Where DF are the dsicount factors of the n-year spot rates

Question 34

What is the periodic settlement value

Answer 34

Where NA is notional amount and 𝐫𝐟𝐱 is called a par swap rate ➞ is a multi-period breakeven rate an investor would be indifferent to: paying 𝐫𝐟𝐱 or paying the forward rates receiving 𝐫𝐟𝐱 or receiving the forward rates

Question 35

Explain the moneyness of an option

Answer 35

Question 36

How does TVM affect the value of an option?

Answer 36

Question 37

Explain the concept of replication with what delta represents

Answer 37

Question 38

How do the value of the underlying, strike price and time to expiration affect option value?

Answer 38

Question 39

Explain how rf, volatility and Income/costs affect option value

Answer 39

Question 40

Explain how put-call parity is derived

Answer 40

Question 41

From put call parity the value of a company can be interpreted as?

Answer 41

Question 42

Formula for hedge ratio and how to solve for C0

Answer 42

Question 43

What is the maximum and minimum price of a call?

Answer 43

Maximum value is the underlying

Question 44

Min and max price for a put

Answer 44

Maximum value is the discounted value of the strike

Question 45

Formula for probability of probability and then call price

Answer 45