Module 66: Derivative Matkets Flashcards
(18 cards)
What is a derivative?
A financial instrument that derives it’s value from the valueof another security or variable
What is the underlying for the derivative?
The security or variable that determines the balue of a derivative security
What are examples of the underlying?
Equities, Bonds, Hard and Soft Commodities, Credit, Credit Indexes
hat is the forward price?
The price at which an underlying asset will be bought or sold in a forward contract.
What is the settlement date (maturity date)?
The date when the transaction in a derivative contract occurs.
What is the contract size?
The quantity of the underlying asset in a derivative contract.
What is the value of a forward contract at initiation?
Zero. No one pays at initiation
How does a buyer of a forward contract profit?
When the market price at settlement is higher than the forward price.
How does a seller of a forward contract profit?
When the market price at settlement is lower than the forward price.
What are the two types of forward contract settlement?
Deliverable (exchange of asset and payment) and cash-settled (exchange of gains/losses).
What is hedging?
Transferring existing risk to another party.
What is speculating?
Increasing risk by entering a derivative contract without an existing offsetting risk.
What are three potential advantages of derivatives over cash market transactions?
Lower cost, lower transaction costs, less market impact.
What are the two type of derivative markets
OTC Markets:
Exchange Trade Derivatives:
What is an OTC Market
- A dealer market with non centralised location
Custom instruments.
Less liquid and have higher transaction costs.
Less transparent.
Subject to counterparty risk.
More difficult to clear and settle.
Subject to higher trading costs.
Not subject to requirements for the deposit of collateral.
What is an Exchange Traded Derivative?
- Traded at a centralized location, an exchange.
- Traded by exchange members (market makers).
- Based on standardized contracts and have lower trading costs.
- Subject to the trading rules of the exchange (i.e., are more regulated).
- Backed by the central clearinghouse to minimize counterparty credit risk. They also require deposits by both parties at initiation, and additional deposits when a position decreases in value.
- More liquid.
- More transparent, as all transactions are known to the exchange and to regulators.
What is a central clearing mandate?
Requires that, for many swap trades, a central counterparty (CCP) takes on the counterparty credit risk of both sides of a trade, similar to the role of a central clearinghouse.
