A put option with an exercise price of $75 sells for a premium of $10. At expiration, the put buyer may experience a loss:
A) of as much as $10.
B) of as much as $65.
C) that is theoretically unlimited.
A is accurate.
The greatest loss a put buyer can experience is the premium paid. If the price of the underlying asset decreased to zero, the put writer would experience a loss of ($0 – $75) + $10 = –$65.
A financial instrument with a payoff that depends on a specified event occurring is most accurately described as:
A) an option.
B) a default swap.
C) a contingent claim.
C is accurate.
Contingent claims are contracts with payoffs that depend on a specified event occurring. Options and credit default swaps are examples of contingent claims, but neither of these terms describes all contingent claims.
Cash Markets
Markets in which specific assets are exchanged at current prices. Cash markets are often referred to as spot markets
Central Clearing Mandate
A requirement instituted by global regulatory authorities following the 2008 global financial crisis that most over-the-counter (OTC) derivatives be cleared by a central counterparty (CCP)
Central CounterParty (CCP)
An economic entity that assumes the counterparty credit risk between derivative counterparties, one of which is typically a financial intermediary. CCPs provide clearing and settlement for most derivative contracts
Contingent Claim
A type of derivative in which one of the counterparties determines whether and when the trade will settle. An option is a common type of contingent claim.
Derivative Contract
A legal agreement between counterparties with a specific maturity, or length of time, until the closing of the transaction, or settlement.
Firm Commitment
A pre-determined amount (price and quantity) is agreed to be exchanged at settlement. Examples of firm commitments include forward contracts, futures contracts, and swaps.
Hard Commodities
Traded natural resources, such as crude oil and metals, with markets often involving the physical delivery of the underlying upon settlement.
Hedging
The use of a derivative contract to offset or neutralize existing or anticipated exposure to an underlying.
Market Reference Rate (MRR)
The interest rate underlying used in interest rate swaps. These rates typically match those of loans or other short-term obligations. Survey-based Libor rates used as reference rates in the past have been replaced by rates based on a daily average of observed market transaction rates. For example, the Secured Overnight Financing Rate (SOFR) is an overnight cash borrowing rate collateralized by US Treasuries. Other MRRs include the euro short-term rate (€STR) and the Sterling Overnight Index Average (SONIA).
Market Makers
Over-the-counter (OTC) dealers who typically enter into offsetting bilateral transactions with one another to transfer risk to other parties.
Novation process
A process that substitutes the initial swap execution facility (SEF) contract with identical trades facing the central counterparty (CCP). The CCP serves as counterparty for both financial intermediaries, eliminating bilateral counterparty credit risk and providing clearing and settlement services
Soft Commodities
Standardized agricultural products, such as cattle and corn, with markets often involving the physical delivery of the underlying upon settlement
Go short
A trading position in a derivative contract that gains value as the price of the underlying moves lower.
Go long
A trading position in a derivative contract that gains value as the price of the underlying moves higher.
