Derivatives

Question 1

Exchange-traded derivatives are backed by a clearinghouse

Answer 1

A dealer with no central location is OTC

Question 2

Forward Commitment is a legally binding promise to perform some action in the future

Answer 2

examples are forward contracts, futures contracts, swaps

Question 3

contingent claim - a claim (to a payoff) that depends on a particular event

Answer 3

An example is an option (depends on the future price of a stock) or a credit derivative (depends on default or downgrade)

Question 4

Forward contract

Answer 4

one party agrees to buy and the counter party to sell a physical or financial asset at a specific risk.

• The party who buys has a long forward position
• The party who sells has a short forward position

Question 5

Futures contract

Answer 5

a forward contract that is standardized and exchange traded. Thus, it has greater regulation than forwards.

Question 6

Swaps

Answer 6

Agreements to exchange a series of payments on periodic settlement dates over a certain period of time.

Question 7

Plain Vanilla Interest Rate Swap

Answer 7

One party makes fixed-rate interest payments on a notional principal amount specified in the swap in return for floating-rate payments from other parties.

Question 8

Basis Swap involves trading one set of floating rate payments for another.

Answer 8

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Question 9

Option Contract gives its owner the right, but not the obligation, to either buy or sell an underlying asset at a given price (exercise/strike price)

Answer 9

• owner of a call option has the right to purchase the underlying asset at a specific price for a specific time period.
• Put option owners have the right to sell the underlying asset at a specific price for a specific time period.

Question 10

Cost of Carry (of a Derivative)

Answer 10

The price of holding the asset.

Question 11

The value of futures and forward contracts are =0 at the time of inception.

Answer 11

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Question 12

Forward rate agreement

Answer 12

• a derivative contract that has a future interest rate, rather than an asset, as it underlying.
• When someone wants to lock in an interest rate.

Question 13

In the money call option

Answer 13

Price of underlying asset - exercise price of the option > 0

Question 14

In the money put option

Answer 14

Exercise price of the option - price of underlying asset > 0

Question 15

Six factors that determine options price

Answer 15

1. Price of underlying asset
2. Exercise price
3. Risk free rate of interest
4. Volatiility of the underlying asset
5. Time to expiration
6. Cost and benefits of holding the asset