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19 Cards in this Set

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What is a derivative (in a financial sense)?
An asset whose value is determined by another asset
What are the three main types of derivatives?
Options, Futures & Swaps
Are derivatives misunderstood? In what way?
Yes they are blamed for many bad situations and considered very risky
What are options?
A contract that gives the holder the right to buy (with a call) or sell (with a put) a certain security at a set price, on or before a given date.
What is a call option?
owner of a call option has the right to buy a quantity of an asset at a set price from a specified person by a specific date.
What is a put option?
owner of a put option has purchased the right to sell a set # of shares of C.S. for a set price on a specific date.
What are futures?
legal, transferrable, standardized contract that represents a promise to buy or sell a quantity of a standardized commodity by a predetermined delivery date.
Discuss the promise to pay, when the contract is purchased or sold, when the transaction is made, and the concept of marking to market.
promise to pay - means you must fufill the obligation.
marking to market - money moves between accounts each day as prices move up and down.
How do futures differ from options?
they differ from options in that you have to legally purchase or sell a future on the specified date. In a option you do not have to exercise it.
How do futures differ from forward contracts?
In forward contracts their is no marking to market. Forward contracts are generally large companies, allows more negotiation than a future, Not standardized, more expensive and more risky
A forward contract is not marketable.
What are Swaps?
Swaps are arrangements where one party trades something with another party
What is an interest rate swap and how does it work?
Difference in interest rate outlook between two parties (due to inflation)
1 firm pays a fixed rate on a sum of money and from some other firm recieves a floating rate of interest on the same sum.
What is a foreign currency swap and how does it work?
Swap interst payments in diff. currencies or a way to get rid of foreign currency.
(risk is the currency you recieve depreciates)
Where do options and futures trade?
Chicago Board Options Exchange, CBOT, Cmex, Nymex

or over the counter as OTC derivatives
What are some examples of underlying assets for futures and options?
Stocks, Market Indexes, metals, interest rates,
Futures contracts, currencies
Futures underlying assets may be: Wheat, Live Cattle, Oil, US dollar, TBonds, Stock Market Indexes
Who regulates option markets? Futures markets?
SEC- options Markets
Commodity Futures Trading Commission (CFTC)- futures considered contracts not securities
Who are the three primary market participants for derivatives?
Hedgers-trying to remove a risk
Speculators-A person or firm who accepts the risk the hedger does not want to take
Arbitragers-persons actively engaged in seeking out minor pricing discrepencies (riskless)
What are the three primary uses of derivative? Briefly give an example of how derivatives might accomplish each use.
Risk Management- reducing & Managing risk exposure
Income Generation- owning the underlying stock + writing a call option on the stock.
Financial Engineering- the practice of using derivatives as building blocks in the creation of some specialized product.
In a broader sense, how might derivatives be used to manage the following risks?
a. Commodity price risk?
b. Exchange rate risk?
c. Interest rate risk?
a.

b.

c.