Derivatives

Question 1

Derivative

Answer 1

financial instrument that ~derives~ it’s value from the performance of an underlying asset (equities, fixed income, currency, commodities); always a winner and a loser

Question 2

Underlying Asset

Answer 2

value with risk whose performance determines the value of the derivative (equities, fixed income, commodities, currency)

Question 3

Long

Answer 3

buyer of the derivative; holds the long position

Question 4

Short

Answer 4

seller of the derivative; holds the short position

Question 5

Forward Commitment

Answer 5

type of derivative; forces 2 parties to interact in the future at a price previously agreed upon

Question 6

Option/Contingent Claim

Answer 6

right but NOT the obligation to transact in the future at a previously agreed upon price

Question 7

Risk mangement

Answer 7

process that an organization defines the level or risk it wishes to take and measures the level of risk it’s taking, then adjusts; doesn’t get rid of risk

Question 8

Exchange Traded Commodities

Answer 8

matches sellers and buyers; rules/regulations; NYSE

Question 9

OTC Securities Markets

Answer 9

rules and regulations; bring sellers and buyers together in a physical location; not standardized, less regulated

Question 10

Clearing

Answer 10

process where exchange verifies execution of transactions and records them

Question 11

Settlement

Answer 11

exchange transferred money is transferred from one party to another

Question 12

Credit Guarantee

Answer 12

if the loser of a derivative trade can’t pay the clearing house will pay

Question 13

Margin/Performance Bond

Answer 13

cash deposit required by the clearing house for the contract participants

Question 14

Transparency

Answer 14

full information of all transactions is disclosed to exchanges and clearing houses; exchange markets trait

Question 15

International Swaps and Derivatives Association (ISDA)

Answer 15

worldwide organization of financial institutions that engage in derivative transactions (mostly as dealers)

Question 16

“Lay Off”

Answer 16

get rid of

Question 17

Dealer Markets

Answer 17

dealers informally agree to buy/sell various derivatives

Question 18

Forward Commitments

Answer 18

~have~ to transact at the expiration date

Question 19

Fixed Price

Answer 19

forward price; price at which the underlying will be exchanged

Question 20

Forward Contract

Answer 20

OTC contract at a fixed date and price

Question 21

Non-Deliverable Forwards/Cash-Settled Forwards/ Contracts for Differences

Answer 21

cash is exchanged at the end of the contract ~not~ the underlying asset; cash given gives the long enough money to buy the underlying at market value

Question 22

Futures

Answer 22

standardized forward contracts that trade on futures exchanges

Question 23

Characteristic of Future Exchanges

Answer 23

highly regulated; specific underlying assets, expirations, settlement instructions, quantities

Question 24

Futures Price

Answer 24

agreed upon price of the future exhange

Question 25

Mark to Market

Answer 25

daily settlements; aggregate average of identical future trades that is then the settlement price

Question 26

Margin Account

Answer 26

both long and short deposit money into the account to cover losses if one can't deliver; ex: short can't deliver, the long is paid out of the margin account

Question 27

Maintenance Margins

Answer 27

amount of money each party needs to retain in the margin account after the trade is initiated

Question 28

Margin Call

Answer 28

if one party's loss is so great their margin account < maintenance margin they have to deposit enough to cover the initial margin account (not just the maintenance margin)

Question 29

Price Limit

Answer 29

limit based on band relative to the previous day's settlement price

Question 30

Limit Up

Answer 30

trading stops b/c one party wants to trade above the price limit until the parties agree to a price lower than the price limit

Question 31

Lower Limit

Answer 31

trading stops because one party wants to trade at a price below price limit; starts when they agree on a price above the lower limit

Question 32

Locked Limit

Answer 32

when market hits the limits and trading stops

Question 33

Call

Answer 33

right to buy

Question 34

Put

Answer 34

right to sell

Question 35

American

Answer 35

can be called/put at any time before the expiration date

Question 36

European

Answer 36

can only be called/put on expiration date

Question 37

Exercise/Strike Price

Answer 37

fixed price where underlying can be sold/bought

Question 38

Option Premium

Answer 38

fair price of the option in a well functioning market

Question 39

Well-Functioning Market

Answer 39

transparent information and free trade

Question 40

"In the Money"

Answer 40

underlying value > exercise price

Question 41

"Out of the Money"

Answer 41

underlying value < exercise prices

Question 42

Payoff Amount

Answer 42

value of option at expiration

Question 43

"At the Money"

Answer 43

underlying value = exercise price

Question 44

Credit Derivatives

Answer 44

contract between 2 parties with a credit protector buyer and a credit protection seller

Question 45

Total Return Swap

Answer 45

buyer pays the seller the TR (principal and interest payments) of the underlying and the seller pays the buyer a fixed or floating rate of interest; if there's a default on the underlying the seller doesn't get the interest payments but still has to pay buyer the interest

Question 46

Credit Spread Option

Answer 46

underlying is a credit (yield) spread; buyer chooses strike price and pays premium to seller; if option is in the money seller pays buyer established pay off

Question 47

Yield Spread

Answer 47

difference between the bond's yield and the yield on a benchmark default-free bond; shows prediction of risk

Question 48

Credit-Linked Note (CLN)

Answer 48

buyer holds default risk on the underlying and issues a new security (CLN); if the underlying defaults the payoff on the CLN is also reduced; CLN insures credit risk of underlying

Question 49

Credit Default Swap CDS

Answer 49

protection buyer makes regular payments to seller, seller doesn't make any payments until a credit event occurs