Cfa Level 1 Derivatives

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Derivative

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In finance, a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.

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What is the difference between forward and futures contracts?

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. First of all, futures contracts are exchange-traded and, therefore, are standardized contracts. Forward contracts, on the other hand, are private agreements between two parties and are not as rigid in their stated terms and conditions. Because forward contracts are private agreements, there is always a chance that a party may default on its side of the agreement. Futures contracts have clearing houses that guarantee the transactions, which drastically lowers the probability of default to almost never.

Secondly, the specific details concerning settlement and delivery are quite distinct. For forward contracts, settlement of the contract occurs at the end of the contract. Futures contracts are marked-to-market daily, which means that daily changes are settled day by day until the end of the contract. Furthermore, settlement for futures contracts can occur over a range of dates. Forward contracts, on the other hand, only possess one settlement date.

Lastly, because futures contracts are quite frequently employed by speculators, who bet on the direction in which an asset's price will move, they are usually closed out prior to maturity and delivery usually never happens. On the other hand, forward contracts are mostly used by hedgers that want to eliminate the volatility of an asset's price, and delivery of the asset or cash settlement will usually take place

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Clearing House

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An agency or separate corporation of a futures exchange responsible for settling trading accounts, clearing trades, collecting and maintaining margin monies, regulating delivery and reporting trading data. Clearing houses act as third parties to all futures and options contracts - as a buyer to every clearing member seller and a seller to every clearing member buyer.

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Swap

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Traditionally, the exchange of one security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed. Recently, swaps have grown to include currency swaps and interest rate swaps.

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similarities b/w forward and futures

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1.either cash settlement or deliverable
2.are priced to have zero value when contract initialed.

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what are the differences b/w forwards and future?

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1.futures trade on organized exchanges while forwards are private and do not trade/
2.futures are highly standardized.forwards customized contracts.
3.a single clearinghouse is the counterparty to all future.forwards are contracts with the originating counterparty.
4.ther government regulates futures markets.

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Differences b/w forwards and futures

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1.standardized
2.clearinghouse

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initial marign

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the amount of money deposited to initial a margin trading.

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maintenance margin

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the amount of money a margin account has to keep in order to keep the trade

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variation margin

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amount the has to deposited into the account to bring it back to the initial margin

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Settlement Price

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The average price at which a contract trades, calculated at both the open and close of each trading day.

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4 ways to terminate a futures contract

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1.delivery
2.cash-settlement
3.reverse or offsetting trade.
4.exchange for physicals.

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Who decides which contracts be set?

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The exchange

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functions of clearinghouse:

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1.sets initial and maintenance margin
2.act as counterparty of every trade
3.receive margin deposits from brokers.

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American option

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option that can be exercised any time during the during period.

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European option

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option that can only be exercised on the expiration date.

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relationship b/w interest options and forward rate agreement(FRA)

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call + put option = FRA option