Derivatives Flashcards
Derivative Markets: Derivatives
- A derivative security derives its value from the price of another (underlying) asset or an interest rate
- Futures and some options are traded on organized exhanges
- Forward contracts, swaps, and some options are custom instruments created by dealers
Derivative Markets: Forward Commitments and Contingent Claims
Derivative Markets: Forward Contracts
- Customized: No active secondary market
- Lond obligated to buy; short obligated to sell
- Specified asset (currency, stock, index, bond)
- Specified date in the future
- Long gains if asset price is above forward price
- Short gains if asset price is below forward price
Derivative Markets: Futures Contracts
- Like forward constract but standardized
- Exchange-traded, active secondary market
- Require margin deposit
- No defauly (counterparty) risk
Derivative Markets: Swaps
- Equivalent to a series of forward constracts
- Simple interest rate swap
- One party pays a fized rate of interest
- One party pays a variable (floating) rate of interest
- Payments can be based on interest rates or stock/portfolio/index returns
- Can involve 2 different currencies
Derivative Markets: Purpose and Criticism of Derivative
- Derivatives are criticized as being risky and likened to gambling
- Benefits of derivatives markets
- Provide price information
- Lower transaction costs
- Allow the transfer of risk
Derivative Markets: Role of Arbitrage
- Arbitrage is possible when two securities or portfolio have identical future payoffs but different marker prices
- Trading by arbitrageurs will continue until they affect supply and demand enough to bring asset price to efficient (no-arbitrage) levels
- Arbitrage relations are used to value derivatives
Forwards: Forward Contract Positions
Long position (will buy)
The party to the forward constract that agreees to buy the underlying or physical asset
Short position (will sell)
The party to the forward contract that agrees to sell/deliver the asset
Neither party pays at contract initiation
Forwards: Forward Contract Settlement
- Delivery: Short delivers underlying to long for payment of the forward price
- Cash settlement: Negative side of contract pays the positive side
Forwards: Early Termination of Forward
- One party pays the other cash (buys their way out)
- Enter into an offsetting contract
- With a different coutnerparty (Default risk still exists)
- With same (origianl) counterparty (no default risk)
Forwards: Dealers and End Users of Forwards
- A dealer creates a derivative contract and will quote a price to take a long or short position
- An end user is typically a corporation or institution seeking to transfer an existing risk
Forwards: Equity Forward Contracts
Forwards: Equity Index Forward - Problem
Forwards: Forward on Zero-Coupon Bonds - Example
Forwards: LIBOR-Based Loan Example
Forwards: FRA
Forward Rate Agreement (FRA)
Exchange fixed-rate for floating-rate payment
- Notional amount
- Fixed rate = forward (contract) rate
- Floating rate (LIBOR) is underlying rate
- Long gains when LIBOR > contract rate
Long position can be viewed as the obligation to take a (hypothetical) loan at the contract rate(i.e. borrow at the fized rate); gains when reference rate increases
Short position can be views as the obligation to make a (hypothetical) loan at the contract rate (i.e. lend at the contract rate; gains when reference rate decreases
Forwards: FRA - Example
Forwards: FRA Settlement Payment to Long
Forwards: Currency Forward Contracts
- Currency forward contracts are committment to buy or sell a certain amount of a foreign currency for a fixed amount of another currency in the future
- As with other forwards, cash settlements is the amount necessary to compensate the party who would be disadvantaged by the actual change in market rate as of the settlement date
Futures: Chacteristics
Futures: Forwards vs. Futures
Futures: Margin Terms
Futures: Trade - Example
Futures: Price Limits
Futures: Marking-to-Market
Futures: Margin Calculation Example
Futures: Methods to Terminate a Futures Position at Expiration
Futures: Closing a Futures Trade by Offset
Futures: Contract Delivery Options
Futures: Eurodollar Futures
Futures: Treasury Bond Futures
Futures: Stock Index Futures
Futures: Currency Futures
Options: Basics
Options: Terminology
Options: Moneyness
Options: Call Option - Example
Options: Put Option - Example
Options: Exchange-Traded vs. OTC Options
Options: Underlying Assets
Options: Interest Rate Options
Options: Two Interest Rate Option = One FRA - Graph
Options: Interest Rate Caps and Floors
Options: Cap and Floor Payoffs
Options: Interest Rate Option - Problem
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Options: Value
Options: Notation
Options: Minimum and Maximum Values
Options: Differ by Exercise Price
Options: Deriving Put-Call Parity (European Options)
Options: Parity Conditions and Synthetic Options
Options: Put-Call Parity - Problem
Options: Time, Volatility, RFR, and Stock Price
Options: Cash Flows on the Underlying Asset
Swaps: Overview
Swaps: Characteristics
Swaps: Terminology
Swaps: Termination
Swaps: Currency Swaps - Example
Swaps: Plain Vanilla Interest Rate Swap
Swaps: Plain Vanilla Interest Rate Swap - Formula
Swaps: Fixed-for-Floating Swap Example
Swaps: Equity Swaps
Swaps: Equity Swaps - Example
Swaps: Equity Swaps - Problem
Risk Management: Call Intrinsic Value/Payoff at Expiration
Risk Management: Profit and Loss: Call Options
Risk Management: Put Intrinsic Value/Payoff at Expiration
Risk Management: Profit and Loss: Put Options
Risk Management: Call Profit and Loss - Problem
Risk Management: Covered Call Strategy
Risk Management: Covered Call - Problem
Risk Management: Payoffs and Profits - Covered Call
Risk Management: Protective Put Strategy (Position)
Risk Management: Protective Put - Example
Risk Management: Profit and Payoff - Protective Put
