Derivatives

Question 1

ow transaction costs are postulated as the reason for the growth

Answer 1

of derivatives

Question 2

In broad terms, derivatives are used by funds because they

Answer 2

can increase fund returns and/or hedge the risk to the fund of adverse movements in the underlying such as changes in interest rates or the underlying assets

Question 3

Futures contracts were initially created to

Answer 3

> help producers manage the market risk (hedge) of prices.
If understood and responsibly traded, derivative contracts allow traders to speculate, hedge, and earn arbitrage profit.

Question 3

Net cost of carry

Answer 3

= Costs of carry - Benefits of carry

Benefits of carry include: Dividends, interest income and convenience yield.

Costs of carry include: Storage costs, insurance and the funding cost.

Question 3

The value of a swap is equal to the present value of the:

Answer 3

Net cash flows from the swap

> net cash flows would consider the fixed and floating cash flows netted together

Question 4

A synthetic long put can be created by combining

Answer 4

long call, long bond, and short the underlying

Question 5

synthetic protective put

Answer 5

A forward contract F0(T), a risk-free bond and a put option on the underlying

Question 6

binomial option pricing model steps

Answer 6

Step 1 Use the factors to estimate the next two possible prices of the asset
Step 2 Use the asset prices to derive the next two possible option values
Step 3 Compute the risk neutral probability
Step 4 Discount the expected value of the option at the risk-free rate