Derivatives Flashcards
What is a futures contract?
Standardised contract between two parties to buy or sell an asset at a fixed price and date in the future.
What kind of obligation does a futures contract represent?
Binding obligation to buy
What is the clearing house’s role?
To ensure credibility and liquidity of the market.
What will happen if price of underlying asset increases and
investor is long a futures contact?
Will gain. If short and underlying decrease will lose.
What is an option?
Right but not the obligation to buy or sell the underlying asset usually at a pre specified price and time in the future.
What is an option contract?
Gives holder the right to buy an asset known as call option.
What is a put option?
Option contract that gives holder right to sell the asset.
What is the price of option known as?
Option premium and comprises of both intrinsic value and time value.
What is premium of an option generally determined by?
Price of underlying, maturity of option, exercise price, volatility of underlying and prevailing market rate of interest.
When can American style options be exercised?
At any time up to and including the expiry date
When can European style options be exercised?
Only on expiry date
What do traded futures and option contracts allow fund managers to do?
Increase or reduce their exposure to the underlying cash markets.
What may portfolio managers do to earn additional income for their clients?
Lending stock to other parties
Who tends to borrow stock?
Hedge funds who sell shares at current market price hoping to buy them back at a lower price to profit on falling market.
What are the 3 main categories of swaps?
Interest rate swaps, equity swaps, foreign currency swaps.
What do two parties agree to in swaps?
Swap cash flows relating to specified underlying assets ie fixed interest rate for floating rate
What right does a convertible band give investors?
Right to convert their debt holdings in a company for pre-specified amount of ordinary shares.
What is a convertible bond a combination of?
Conventional band and call option on the value of ordinary shares.
What are equity warrants?
Call options issued by a firm on its own stock.
How are equity warrants valued?
Much same way as exchange traded contract but adjustment made to value of warrant to take account of additional ordinary shares which the exercise of the option takes.
What does a credit default swap do?
Provides insurance against bond default
What does collateralised debt obligation involve?
Packaging up collection of revenue generating assets and issuing a band backed by these assets. If CDO made up of credit derivatives is called synthetic CDO
