DERIVATIVES MODULE 70

Question 1

70.1 what do we need to remember about each party at the point of making the no-arbitrage forward contract?

Answer 1

That both parties are neutral, no gain or loss

Question 2

70.1 How can we rearrange the no-arbitrage forward price formula for spot price?

Answer 2

Question 3

70.1 The value to the short party, will simply be the ____ to the long party’s gain.

Answer 3

Negative

Question 4

70.1 what is the formula for calculating the value to the long party?

Answer 4

ST = value of the spot price at maturity

little t = time prior to maturity

T - t = the time due to maturity of the forward contract

Question 5

70.1 What is an FRA?

Answer 5

FORWARD RATE AGREEMENT

(it is basically locking in an interest rate on a fake loan) (notional) - therefore the creditworthiness of the borrower does not play any part in the transaction

NA = notional amount

So they receive the floating rate, but PAY a fixed rate.

So they gain when the rates go up

‘FIXED = FORWARD RATE’

Question 6

70.1 What is a ‘spot rate’

Answer 6

It is a loan locked in today, then there are no periodic payments or amortisation of the loan, it is just repaid all on the maturity of thre loan

Question 7

70.1 What does this notation mean?

Answer 7

Question 8

70.1 How could you replicate the previous FRA?

Answer 8

Question 9

70.1 Demonstrating FRA payoffs: the loan buyer gains

Answer 9

Settlement amount will be PV of the end payoff at the T90 when the MRR is revealed

This is discounted at half the spot rate

Question 10

70.1 Demonstrating FRA payoffs: the loan buyer loses

Answer 10

Question 11

70.1 What are the uses of FRA?

Answer 11

corporations can reduce their exposure to rate changes

Question 12

70.1 YTM is simply…

Answer 12

A weighted average of underlying spot rates

Question 13

70.1 What is bootstrapping spot rates?

Answer 13

Working out spot rates of each type of security to solve for a later one

Question 14

70.1 What is an IFR?

Answer 14

Implied forward rates

Working out a forward rate after being given other forward rates

Question 15

70.1 REMEMBER, always to calculate a spot rate

Answer 15

you need two underlying spot rates, such that the forward rate os the non overlapping portion

Question 16

70.1 At time t, prior to its settlement date at time T, the value Vt of a long forward with a price of F will be related to the spot price, S, of an asset that has no holding costs or benefits by:

Answer 16

Question 17

70.1 The most likely use of a forward rate agreement is to:

Answer 17

lock in an interest rate for future borrowing or lending.

Question 18

70.1 The value of a forward or futures contract is:

Answer 18

typically zero at initiation.

The value of a forward or futures contract is typically zero at initiation, and at expiration is the difference between the spot price and the contract price. The price of a forward or futures contract is defined as the price specified in the contract at which the two parties agree to trade the underlying asset on a future date.