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60 Cards in this Set
- Front
- Back
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How did derivatives originate? |
They trace back to agricultural markets where farmers needed to guard against price fluctuation. In advance of harvest time they would enter into forward contracts. These meant a stated amount of a commodity would be exchanged at a set price at a future date. |
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When was the first derivatives market opened? |
1848 - The Chicago board of trade (CBOT)what ar |
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What are commodity markets? |
They are markets where raw or primary products are exchanged or traded on regulated exchanges. They are traded in standardised contracts. |
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What is a standardised contract? |
One where not only the amount and of timing of contracts conform with the exchange norm but also the quality and form of the underlying asset. Eg the purity of metals |
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Why is most of the trading undertaker via commodity derivatives? |
It offers the ability for producer and consumer to hedge their exposure to price movements. |
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What are the 4 forms of derivatives? |
Forwards Futures Options Swaps |
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What is the definition of a derivative? |
A financial instrument whose price is based on the price of another asset, known as the underlying asset or simply 'the underlying' eg. Oil price effects petrol. |
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What are examples of financial assets and commodities |
Financial assets Bonds Shares Stock market indices Exchange rates
Commodities Oil Silver Wheat |
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How can derivatives trading take place? |
- Directly between counter parties (OTC)
- On an exchange such as LIFFE (exchange traded) |
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How can derivatives trading take place? |
- Directly between counter parties (OTC)
- On an exchange such as LIFFE (exchange traded) |
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Derivatives play a major role in the investment of large portfolios and funds. What are they used for? |
1)Hedging 2)Anticipating future cash flow 3)Asset allocation changes 4) Arbitage |
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What is hedging? |
A technique employed by portfolio managers to reduce the impact of adverse price movements.Normally by selling futures or buying put options |
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What is anticipating future cash flows? |
If a portfolio manager expects to receive a large inflow of cash to be invested in a particular asset, then futures can be used to fix the price at which is will be bought. This offsets the risk that prices will have by the time cash is received |
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What is hedging? |
A technique employed by portfolio managers to reduce the impact of adverse price movements.Normally by selling futures or buying put options |
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What is anticipating future cash flows? |
If a portfolio manager expects to receive a large inflow of cash to be invested in a particular asset, then futures can be used to fix the price at which is will be bought. This offsets the risk that prices will have by the time cash is received |
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What are asset allocation changes? |
Changes to the asset allocation of a fund. Whether this is to take advantage of anticipated short term directional markets movements or to implement a change in strategy. These can be made more swiftly and less expensively using derivatives. |
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What are asset allocation changes? |
Changes to the asset allocation of a fund. Whether this is to take advantage of anticipated short term directional markets movements or to implement a change in strategy. These can be made more swiftly and less expensively using derivatives. |
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What is arbitrage? |
The process of deriving a risk free profit from simultaneously buying and selling the same asset in two different markets when a price difference between the 2 exists. |
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What are futures? |
They are contracts that enable standardised qualities and quantities to be traded at a fixed price at a future delivery date. |
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What are futures? |
They are contracts that enable standardised qualities and quantities to be traded at a fixed price at a future delivery date. |
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When was the first futures contract introduced? |
1975 |
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What are the 2 distinct features of a future? |
1) Exchange traded - On derivative exchanges such as LIFFE 2) Standardised terms - The exchange specifies the quality of the asset and the future delivery date. Only the price is negotiable |
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What does 'Long' mean in futures terminology? |
Long - the term used for the position taken by the buyer. |
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What does 'Short' mean in futures terminology? |
Short - The position taken by the seller |
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What does 'Long' mean in futures terminology? |
Long - the term used for the position taken by the buyer. |
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What does 'Short' mean in futures terminology? |
Short - The position taken by the seller |
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What does 'Open' mean in futures terminology? |
Open - The initial trade. This is when a participant first enters into a contract. |
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What does 'Open' mean in futures terminology? |
Open - The initial trade. This is when a participant first enters into a contract. |
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What does 'Close' mean in futures terminology? |
Close - when the physical assets underlying the most futures that are opened do not end up being delivered. They are 'closed out' instead |
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What does 'Long' mean in futures terminology? |
Long - the term used for the position taken by the buyer. |
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What does 'Short' mean in futures terminology? |
Short - The position taken by the seller |
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What does 'Close' mean in futures terminology? |
Close - when the physical assets underlying the most futures that are opened do not end up being delivered. They are 'closed out' instead |
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What does 'Covered' mean in futures terminology? |
Covered - when the seller of the future has the underlying asset that will be needed if physical delivery takes place |
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What does 'Long' mean in futures terminology? |
Long - the term used for the position taken by the buyer. |
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What does 'Short' mean in futures terminology? |
Short - The position taken by the seller |
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What does 'Open' mean in futures terminology? |
Open - The initial trade. This is when a participant first enters into a contract. |
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What does 'Close' mean in futures terminology? |
Close - when the physical assets underlying the most futures that are opened do not end up being delivered. They are 'closed out' instead |
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What does 'Covered' mean in futures terminology? |
Covered - when the seller of the future has the underlying asset that will be needed if physical delivery takes place |
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What does 'Naked' mean in futures terminology? |
Naked - when the seller of the future does not have the asset that will need to be delivered. The risk could be unlimited |
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What are Options? |
An option gives the buyer the right, but not the obligation to buy or sell a specified quantity of an asset at a pre agreed price. The seller will exchange a premium payment that grants the option to the buyer. |
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How are options traded? |
They are exchange traded but from time to time investors may trade options outside of the standardised terms and this will be done OTC. |
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How are options traded? |
They are exchange traded but from time to time investors may trade options outside of the standardised terms and this will be done OTC. |
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What are the 2 classes of options? |
Call option Put option |
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How are options traded? |
They are exchange traded but from time to time investors may trade options outside of the standardised terms and this will be done OTC. |
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What are the 2 classes of options? |
Call option Put option |
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What is a call option? |
Where a buyer has the right to buy the asset at the exercise price. The seller is obliged to deliver if the buyer exercises the option |
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How are options traded? |
They are exchange traded but from time to time investors may trade options outside of the standardised terms and this will be done OTC. |
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What are the 2 classes of options? |
Call option Put option |
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What is a call option? |
Where a buyer has the right to buy the asset at the exercise price. The seller is obliged to deliver if the buyer exercises the option |
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What is a put option? |
When a buyer has the right to sell the assets at the excessive price. The seller of the option is obliged to take delivery and pay the price if the buyer exercises the option. |
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What are buyers and sellers referred to as? |
Sellers > Writers Buyers > Holders |
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What is a premium? |
The money paid by the buyer/holder to the exchange at the beginning of an option. This is not refundable. |
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What is a swap? |
The agreement to exchange one set of cash flows for another. They are most commonly used to switch financing from one currency to another. They are OTC traded. |
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What are interest rate swaps? |
-The most common form of swaps.
-They are the exchange of interest payments.
- Usually where one leg is a fixed rate of interest and the other leg a payment of a floating interest rate.
- Usually used to hedge exposure to interest rate changes.
- amounts exchanged are calculated by reference to the notional amount |
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What are credit default swaps? |
- Instruments whose value depend on agreed credit events relating to a 3rd party company
- Purpose is for organisations to protect itself against unwanted credit exposure |
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What forms of derivatives are usually OTC traded? |
Interest rate swaps Forward rate agreements All other exotic derivatives |
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What are the main types of physical markets? |
- Agricultural markets - base and precision markets - energy markets - power markets - plastic markets |
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What are the 3 main Derivatives markets? |
LIFFE The main exchange for trading financial derivatives products in the UK including futures and options on interest rates and bonds, equity indices and individual equities. Now part of ICE
EUREX The worlds leading international derivatives exchange. Based in Frankfurt also trades index products for a range of European Markets. Created by Deutsche Borse.
Intercontinental Exchange(ICE) Operates the electronic global futures and OTC marketplace for trading energy commodity contracts. These contracts include crude oil and refined products.
London Metal Exchange (LME) The worlds premier non ferrous metals market and has been in operation for over 130 years. Based in London with 95% of business overseas
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What are the advantages of investing in derivatives? |
1) Enables producers and consumers to agree the price of a commodity today for future delivery.
2) Enables investment firms to hedge there risk
3) Offers the ability to speculate on a wide range of assets and markets |
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What are the disadvantages of investing in derivatives? |
1) some derivatives may make investors lose more than there initial outlay.
2) market thrives on price volatility so professional skill and experience are needed
3) a risk a counterpart may default on there obligations |
