L9 - FRM 2

Question 1

What is the core function of forward and future contracts?

Answer 1

Obligation/ agreement to buy/ sell an asset in the future

Question 2

How does a futures contract reduce default risk?

Answer 2

Daily settlement (marking to market) essentially creates a series of one-day contracts

Question 3

What are the two main types of swaps?

Answer 3

Interest rate (plain vanilla) swaps and currency swaps

Question 4

What is the notional principal in an interest rate swap?

Answer 4

The amount on which the interest payments are determined, but it is not actually exchanged

Question 5

What are the three cash flows in a currency swap?

Answer 5

• Exchange of principal at inception
• Periodic interest payments
• Exchange of principal at termination

Question 6

Give examples of derivative instrument purposes

Answer 6

Hedging and speculative

Question 7

Describe OTC markets in relation to forwards

Answer 7

Can be tailored

Question 8

What are some advantages of exchanges in Futures contracts?

Answer 8

• Clearing house
• Liquidity
• Standardisation

Question 9

What are some disadvantages of exchanges in futures contracts?

Answer 9

• Lack of flexibility
• Regulation
• Trading fees

Question 10

What are some disadvantages of OTC markets?

Answer 10

• Credit risk
• Low liquidity
• Non-standardisation

Question 11

Describe hedging

Answer 11

Taking a position that offsets an existing risk