Chapter 9 Derivatives

Question 1

Derivatives definitions

Answer 1

Instruments with a price which is depended upon or derived from one of more underlying financial values

Question 2

Derivatives characteristics

Answer 2

1. Used to hedge (credit) risk
2. Can be traded on exchange or OTC
3. Must be reported to trade repositories

Question 3

Contracts for Difference (CFD)

Answer 3

Most derivatives are cash settled; no transfer of underlying value
Examples are: FRA, NDF and STIR Futures

Question 4

Forward Rate Agreements (FRA)

Answer 4

• OTC derivative
• Traded on Money market
• 2 parties enter in a mutual obligation to settle the difference between an interest specified in the contract and the interest on fixing date.
• Hedging interest risk

Question 5

Buyer of a FRA

Answer 5

Betting on an increase of the reference rate

Question 6

Seller of a FRA

Answer 6

Betting on a reference rate that is lower than the contract rate on fixing date

Question 7

FRA contract

Answer 7

1. Notional amount
2, Reference interest rate (EURIBOR/LIBOR)
3. Contract interest date 
4. Fixing date
5. Settlement date
6. Underlying period
7. Who the buyer/seller is

Question 8

Contract term FRA

Answer 8

Contract date to the fixing date

Question 9

Underlying period FRA

Answer 9

Starts on settlement date

Question 10

Fixing FRA

Answer 10

2 days before start date of underlying period (=trade date)

Question 11

Settlement FRA

Answer 11

Start date of underlying period

Question 12

Effective rate FRA

Answer 12

Always the forward rate

Question 13

Money Market Future (STIR Future)

Answer 13

Same instruments as FRA but traded on a exchange

Question 14

Standardized conditions STIR Future

Answer 14

1. Underlying periods 1 or 3 months
2. Contract amounts
3. Daycount convention 30/360 over all currencies
4. Start dates (IMM dates) Third wednesdays in March, Jun, Sep, Dec.
5. Contract term is period before start date

Question 15

Opening buy or sell

Answer 15

If a member has no other contracts and is selling/buying a future

Question 16

Closing buy or sell

Answer 16

Later transacting the opposite transaction

- The first contract is offset

Question 17

Exchange traded process

Answer 17

1. Banks sends an order
2. Exchange sends conf.
3. Exchange sends details to CCP
4. CCP sends details on value and margin payments to bank
5. If the value decreased the bank has to make a payment to CCP margin account

Question 18

MM Future Short Sterling

Answer 18

• Unit: GBP 500.000
• Tick: 1 bp
• Traded on NYSE ICE

Question 19

MM Future Eurodollar

Answer 19

• Unit: USD 1 mio
• Tick: 0.5 bp (0.25 bp)
• Traded on NYSE ICE, CME , SGX

Question 20

MM Future EURIBOR

Answer 20

• Unit: EUR 1 mio
• Tick: 0.5 bp
• Traded on NYSE ICE- Unit: GBP 500.000
• Tick: 1 bp
• Traded on NYSE ICE, EUREX, CME

Question 21

MM Future EuroSwiss

Answer 21

• Unit: CHF 1 mio
• Tick: 1 bp
• Traded on NYSE ICE, CME

Question 22

MM Future Euroyen

Answer 22

• Unit: JPY 100 MIO
• Tick: 0.5 bp
• Traded on TFX, CME

Question 23

Price of MM Future

Answer 23

100 -/- implied forward rate

Price goes up if the forward rate goes down

Question 24

Buyer of a STIR Future

Answer 24

Speculating on the fall in the interest rate

Question 25

Seller of a STIR Future

Answer 25

Speculating on the rise in the interest rate

Question 26

Implied forward rate

Answer 26

100- underlying benchmark rate (LIBOR, EURIBOR etc))

Question 27

Last trading date STIR future

Answer 27

2nd working day before 3rd wednesday (11.00 am)

Question 28

Exchange Delivery Settlement Price (EDSP)

Answer 28

Fixing price STIR Future

Question 29

Interest rate swaps

Answer 29

- OTC contract in which 2 parties enter in a reciprocal oblogation to exchange coupons - Used to covert a floating coupon for a fixed and viceversa - Same function as FRA, but can be used over a longer period

Question 30

Price of IRS

Answer 30

- Fixed rate | - Spread over the yield of government bonds

Question 31

Buyer (Payer) of an IRS

Answer 31

- Pays the fixed rate | - Profits from increase

Question 32

Seller (Receiver) of an IRS

Answer 32

- Pays to floating rate | - Profits from a drop

Question 33

Cash flows of a receiver's IRS

Answer 33

1. Plain vanilla: Paying fixed, receiving floating 2. ISDA: fixed coupons netted against floating 3. Fully synchronized

Question 34

Asset swap

Answer 34

Combination of a fixed rate bond and an IRS

Question 35

Overnight index swap (OIS)

Answer 35

OTC derivative in which 2 parties agree to exchange interest payments in the same currency with the floating coupon based on an overnight interest rate index (EONIA, SONIA etc) - Floating coupon is not paid daily but at the end of contract term or anually

Question 36

Options

Answer 36

1. Financial instruments that give one party a unilateral right to enter into a transaction at a specific future date: physical transfer 2. To receive a payment if certain conditions are met at a future date: cash settlement

Question 37

Why use options?

Answer 37

1. Speculation: limited loss potential, unlimited profit potential 2. Hedging: no opportunity loss, no obligation if the underlying position is uncertain

Question 38

Call option

Answer 38

Right to buy

Question 39

Put option

Answer 39

Right to sell

Question 40

Strike price

Answer 40

Predetermined price or interest rate in an option contract

Question 41

Cut-off times

Answer 41

1. Interbank Europe, US: 10 am NY time | 2. Interbank Pacific: 3 pm Tokyo

Question 42

European expiration style

Answer 42

The buyer is only entitled to exercise his right on the expiry date - OTC

Question 43

American expiration style

Answer 43

Buyer can exercise his right at any time | - Stock exchange

Question 44

Bermudan expiration style

Answer 44

Buyer can exercise his right on specific moments

Question 45

Delta

Answer 45

The relationship between an absolute change in the option price and an absolute change in the underlying value 2. The chance that the option will be exercised-

Question 46

Long straddle

Answer 46

An option strategy (more than 1 option)

Question 47

Interest rate guarantee

Answer 47

Option on either a bought or sold FRA

Question 48

Floor / CAP

Answer 48

Consists of a number of consecutive interest rate guarentees with the same exercise price

Question 49

Collar

Answer 49

Buy a cap and sell a floor: long collar | Sell a cap, buy a floor: short collar

Question 50

Swaption

Answer 50

Option for an IRS