Module 67.2: Swaps and Option Flashcards
(21 cards)
What are swaps?
A firm commitment under which two counterparties exchange a series of cash flows in multiple points in the future
What are the cash flows based off?
One of the cash flows are based on a variable/floating cash flow (based on something that updates periodically)
The cash flows are typically fixed.
What is a swap rate and swap notional?
Swap Notional: The size of the contract
Swap rate: Fixed rate interest rate
What is an interest rate swap?
At schedules settlements, the fixed rate payer pays a fixed IR * notional to the other party, whereas the variable rate payer pays a percentage of an MRR * notional
How is settlement made?
Net payments are made, so the net winner
What is a credit default swap?
A protection buyer (e.g. a fund holding corporate bonds), that generates a yield, but has credit risk.
For a fixed fee, you can buy protection for the protection seller, in the exchange for a contingent payment if a credit event happens.
What are examples of credit events
Failure to make a bond payment, corporate bankrupcy, involuntart restructuring
What does the protection seller cover?
The protection seller pays a reflection of the loss suffered by the bondholder
Calculation: LGD(%) * Notional
Who is short and who is long the credit risk?
Protection Buyer: Short the credit risk
Protection Sellerr: Long the credit risk
Where are options
They are traded OTC or Exchange Traded
What are options
These are contingent claims where one counterparty can decided whether to settle
Who is the option buyer
Someone who has the right, but not the obligation to settle/transaction who must pay a premium (Option Premium) to the option seller (or writer)
What’s the difference between European and American Options?
European Options: May only be exercised at the expiration date
American Options: Can be exercised anytime between the inception of the contract and the maturity.
What does it mean to be in the money?
Call Options: if St > exercise price (you would exercise the option now)
Put Option: St < exercise price (you would exercise the option now)
St = spot price at time t (anytime)
What does it mean to be out of the money
Call Options: St < exercise price (so you wouldn’t exercise it)
Put Option: St > exercise price (so you wouldn’t exercise it)
St = spot price at time t (anytime)
What does it mean being at the money
Call Option: X = St
Put Option: X = St
What’s the formula for the Payoff of whoever’s Long on the call options
Payoff = Max (0,St-X)
St = Spot price at maturity
X = exercise price
What is the break even price of a call option for the buyer?
St = Exercise Price + Premium
What’s the formula for the Payoff of whoever’s short on the call options
–max (0, ST - X).
What’s the formula for the Payoff of whoever’s Long on the put options
Payoff = Max (0,X-St)
St = Spot price at maturity
X = exercise price
What is the break even price of a put option for the buyer?
