Reading #57 - Intro for Derivs

Question 1

define over-the-counter

Answer 1

dealer market with no central location

Question 2

define forward commitment

Answer 2

“legally binding promise to perform some action in the future. they include forward contacts, futures contracts, etc”

Question 3

define contingent claim

Answer 3

“claim to a payoff that depends on a particular event” - ex. options

Question 4

define forward contract

Answer 4

“one party agrees to buy and the counterpart to sell at a specific price on a specific date in the future”

Question 5

define futures contract

Answer 5

standardized and exchange-traded forward contract.

Question 6

difference between fwd and futures contract

Answer 6

futures are backed by a clearing house and traded on a secondary market

Question 7

define swap

Answer 7

series of fwd contracts. one party agrees to pay short term rate of interest on a princ. amt. and counterparty pays certain (fixed) rate of int. in return

Question 8

define call option

Answer 8

option to buy an asset at particular price

Question 9

define put option

Answer 9

option to sell an asset at a particular price

Question 10

define credit derivative

Answer 10

“contract that provides bondholder with protection against downgrade/default by borrower”

Question 11

example of credit derivative

Answer 11

CDS - credit default swap or Credit spread option

Question 12

define credit spread option

Answer 12

“call option is based on bond’s yield spread against a benchmark”

Question 13

What are the three benefits of derivatives markets?

Answer 13

provide price information, allow risk to be mnged and shifted amg party participants, and reduce transaction costs

Question 14

define law of one price (type of arbitrage)

Answer 14

“two securities or portfolios that have identical cash flows in the future, regardless of future events, should have the same price”