Lecture 9 Flashcards
(12 cards)
1
Q
What are the four main Financial Risks faced by corporations?
A
- Commodity price risk: agricultural, energy and metal
- Interest rate risk
- Credit risk
- Foreign Exchange risk / “FX” risk
2
Q
Which tools are often used for hedging?
A
- Forward contracts
- Futures contracts
- Option contracts
- Swaps
3
Q
What are Forward Contracts?
A
- Agreement to buy or sell an asset at some date in the future at a price agreed today.
- It is NOT an option. Both the buyer and seller are obligated to perform under the terms of the contract.
- They agree the terms of the contract today but exchange the asset and money at the agreed day in the future.
4
Q
What are Futures Contracts?
A
- Agreement to buy or sell an asset at some date in the future at a price agreed today.
- It is NOT an option. Both the buyer and seller are obligated to perform under the terms of the contract.
- It is a more standardized form of a forward agreement.
5
Q
What is the difference between Forwards and Futures Contracts?
A
- A futures seller can choose to deliver an underlying asset on any day during the delivery term: either before or at the delivery. In forward contracts, assets are delivered only at the delivery date.
- Futures contracts are traded on an exchange, whereas forward contracts are generally not traded on exchanges.
- The prices of futures contracts are marked to the market daily while the prices of forward contracts are fixed on the day of agreement for the delivery date.
6
Q
What are Options?
A
- An option is a derivative. Its value is derived from an existing security.
- It is a contract giving its owner the right (not the obligation) to buy or sell an asset (where its value is derived from) at a fixed price on or before a given date => buyer not obligated to buy asset at the predetermined price
- Let’s explore that a bit further:
Exercise price (Strike price): The predetermined fixed price for the underlying asset to be bought (or sold) if an option is exercised
Spot price: The market price of the underlying asset
7
Q
What are long positions on an option?
A
- The holder (i.e. buyer) of the option holds the long position, i.e. right to exercise the option (which is buying the underlying asset or selling it depends on if it’s a call or put option)
- Price rise = profit
- Don’t get confused: Buying the option ≠ Buying the underlying assets
8
Q
What are short positions on an option?
A
- The writer (i.e. seller) of the option holds the short position, i.e. she has the obligation to buy /sell the underlying assets if the buyer exercises the option depends on if it’s a call or put option
- Price falls = sell at a price higher than the market = profit
- Don’t get confused: Buying the option ≠ Buying the underlying assets
9
Q
What is the difference between a European and American Option?
A
- European options can be exercised only on expiration date: e.g. S&P 500 index options
- American options can be exercised at any time up to and including the expiration date: e.g. single stock options
- When you exercise an option, it is called “in the money” if you can make some profits. If no profit can be earned, it becomes “out of the money”. An “at the money” option has a strike price equal to the spot price (not making profit or loss).
10
Q
What are the different types of options?
A
- A call option gives the holder (buyer) the right to buy an asset at a fixed price on or before the expiration date.
- A put option on the other hand, gives the holder (buyer) the right to sell an asset at a fixed price on or before the expiration date.
11
Q
What is an option combination?
A
- Options can be used to protect against risk of losing money as the prices of shares and bonds fluctuates.
- Call and put options with different strike prices can be bought and sold simultaneously along with the stocks and bonds in a combination.
12
Q
What is a Protective Put?
A
Buy a share and a put option of that share at the same time
