Lecture 8: Derivatives

Question 1

What are derivatives?

Answer 1

derive all or part of their value from another security

Question 2

Why do derivatives exist?

Answer 2

1. They are actively traded
2. They allow for more investment opportunities
3. lower cost
4. Increase leverage: returns are magnified

Question 3

What are options

Answer 3

options are sold to give you an option of buying something else

Question 4

What are call options?

Answer 4

you have bough the ability to call (buy) the option

Question 5

What are put options?

Answer 5

you have bought the ability to sell the option

Question 6

What is the exercise price?

Answer 6

the amount that you buy each share for

ex. $1 for 100 shares

Question 7

What is the option premium?

Answer 7

Is the amount that you buy the option to buy the shares for

Question 8

What is the expiration date? And what are the 3 kinds?

Answer 8

the last date that the option can be exercised

1. American
2. European
3. Bermudan

Question 9

What is an American expiration date?

Answer 9

you can buy the exercise any dat within the time frame

Question 10

What is the European expiration date?

Answer 10

you can only buy the option on a special day

Question 11

What is the Bermudan expiration date?

Answer 11

you can buy the option on 1+ specific days of a time frame

Question 12

What does the buyer and seller expect the price to do in a call option?

Answer 12

buyer: expects the price to increase (bullish)
seller: expects the price to decrease (bearish)

Question 13

What does the buyer and seller expect the price to do in a put option?

Answer 13

buyer: expects the price to decrease (bearish)
seller: expects the price to increase (bullish)

Question 14

What are the two types of trading options?

Answer 14

1. ME

2. CBOE -chicago board options exchange

Question 15

What does options trading do?

Answer 15

facilitates offsetting positions through a clearing corporation

Question 16

What happens to the call and put option in the “in-the-money” option?

Answer 16

Call: S>E
Put: E>S

Question 17

What happens to the call and put option in the “out-of-the-money” option?

Answer 17

Call: E>S
Put: S>E

Question 18

What factors affect prices?

Answer 18

Stock price
Exercise Price
Time and Maturity
Stock Volatility
Interest Rates
Cash Dividend

Question 19

What is a right?

Answer 19

You have the right to purchase a number of shares on a specific time and price (few months)

Question 20

Is a right transferrable or detachable?

Answer 20

transferrable

Question 21

What is a warrant?

Answer 21

you have the warrant to purchase a number of shares at a specific time and price (within years)

Question 22

What is a warrant usually attached too?

Answer 22

debt

Question 23

What is spot or cash market?

Answer 23

price refers to immediate delivery

Question 24

What is forward market?

Answer 24

price refers to delayed delivery

Question 25

What is future market?

Answer 25

set features for delivery

Question 26

What are 2 characteristics of a future market?

Answer 26

1. A place where investors can trade with one another | 2. performance is monitored by a clearing house

Question 27

What are 2 types of future markets?

Answer 27

1. commodities (agriculture, metal, energy) | 2. financials (currencies, debt)

Question 28

What are future exchanges?

Answer 28

they are nonprofit, voluntary places where future contracts are traded with established rules

Question 29

What is a clearing corporation?

Answer 29

a corporation associated with exchange (mediator)

Question 30

What is the short position?

Answer 30

seller that commits a trader to deliver at contract maturity

Question 31

What is long position?

Answer 31

a buyer that commits a trader to purchase an item at contract maturity

Question 32

What is a future margin?

Answer 32

good faith deposit between a buyer and seller usually being a less than 10% initial

Question 33

When do margin call? and what is then to happen?

Answer 33

when price goes against investor - deposit cash or close account, make marked to market daily or withdraw profit

Question 34

What is a maintenance or variation of a future margin contract?

Answer 34

where the investor's net equity cannot drop below

Question 35

What are hedgers?

Answer 35

are people that need or have the commodity. they watch their ass buy purchasing futures to offset risk

Question 36

What are speculators?

Answer 36

these are people that are just looking for a quick buck. they absorb X/S demand generated by hedgers and assume the risk that hedgers avoid