Derivatives Flashcards
What are commodity derivatives used for?
They help producers and consumers cut down their exposure to price movements.
These instruments allow for risk management in commodity trading.
Who engages in substantial trading of commodities and their derivatives?
Financial firms and speculators.
They aim to make profits by predicting market movements.
What is hedging in the context of derivatives?
It is used to reduce the impacts of adverse price movements on a portfolio’s value.
What is the purpose of anticipating future cash flows with futures?
To fix the price at which an asset will be bought, mitigating the risk of price increases.
What are asset allocation changes?
Changes to the asset allocation of a fund to take advantage of anticipated market movements or to implement a change in strategy.
What is arbitrage?
The process of deriving a risk-free profit from simultaneously buying and selling the same asset in two different markets.
What are the two main features of futures contracts?
- They are exchange traded.
- They are dealt on standardized terms.
Define ‘Long’ in futures terminology.
A person who is long on the contract has to buy the asset at the agreed price on the specified date.
Define ‘Short’ in futures terminology.
The seller has to deliver the asset.
What does ‘Open’ mean in futures terminology?
The initial trade when a participant first enters into a future.
What does ‘Close’ refer to in futures contracts?
Most contracts are closed out instead of being delivered.
What is a ‘Covered’ position in futures?
The seller has the asset that will be needed if physical delivery takes place.
What is a ‘Naked’ position in futures?
The seller does not have the asset that will be needed when delivery is supposed to take place.
What is the definition of an option?
An option gives the buyer the right to buy a set quantity of an asset at a pre-agreed price on or before a specified date.
What is the key difference between an option and a future?
An option gives a right to buy, while a future is a legally binding agreement to buy.
What is a call option?
The buyer has the right to buy the asset at a price if they choose to.
What is a put option?
The buyer has the right to sell the underlying asset at the agreed price.
Who are the sellers of options known as?
Writers.
What is a swap?
An agreement to exchange cash flows, commonly used to switch financing from one currency to another.
What is a credit derivative?
An instrument whose value depends on changes to the credit rating of a company.
Name one derivatives exchange.
- Ice Futures Europe (London)
- Eurex (Germany)
- The London Metal Exchange
List one advantage of investing in derivatives.
- Removes uncertainty by agreeing on a price today for future delivery.
- Allows hedging of risk for shares or stocks.
- Enables speculation on a wide range of assets and markets.
List one disadvantage of investing in derivatives.
- Some derivatives can lead to losses exceeding the initial investment.
- They thrive on price volatility requiring professional skills.
- OTC markets carry default risks.
