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22 Cards in this Set
- Front
- Back
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How do you calculate beta from covariance?
What is the formula to modify a portfolio beta with futures? |
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Hedges are rarely perfect. Research cant find it
What is basis risk and what are the typical reason basis risk occurs? |
Basis risk occurs whenever the hedged item is not a perfect match for the hedging vehicle.
Typical reasons: 1) Numerator and Denom are not on the same item. 3) Hedge results are complicated by contract expiration. Hedge could be closed before the contract even expires or may have to be extended past contract expiration. 4) Rounding of contracts. 5) Future and spot price are not fairly based on cash and carry model. 2) Beta and durations used in the hed calc are not representative of subsequent MV or contract changes. Common. |
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What is effective beta? |
It is the return of a portfolio over the return of the market. |
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What is required to create a synthetic bond or equity position? |
Risk free bond=long stock+short futures Long stock=Risk free bond + long futures |
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Research into dividend yield and Synthetic calculations |
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Formula for duration modification |
Yield beta must be given. |
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Why is it best to pre invest with contracts? |
Buying contracts do not require initial cash. |
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What are the 3 types of foreign exchange risks that affect normal business transactions? Needs clarification |
Transaction exposure: when a cash flow in a foreign currency will be received and paid at a future date.
Economic exposure: when changes in currency affect company effectiveness. 1) If a company exports and Domestic currency increases, company is less competitive 2) If a company import parts, then dropping domestic currency increases costs. 3) even if no export or imports, currency changes can influence competitors.
Translation exposure: Accounting. Risk of converting foreign into domestic currency units. |
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How do you use a forward to hedge a foreign currency contract? |
If in long position in a Forward contract, then hedge by selling the contract and vice versa. |
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What are the risks involved with investing in foreign markets? (General answer) How can you hedge against these risks? |
There are both the risk of the foreign market itself and the currency risk.
You can protect against both, either one, or none of them. |
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How does the manager hedge the market risk of a portfolio vs the foreign security it is invested in and what determines its effectiveness? |
A manager can short the foreign market index. The effectiveness depends on how correlated the index is to the manager's portfolio. |
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How does the manager determine the amount to hedge the currency risk with?
What strategies can the manager use? |
1) Hedging a minimum future value below which they feel the portfolio will fall. 2) Hedge the estimated future value of the portfolio 3) Hedge the initial value of the portfolio
or one strategy is just do nothing. |
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(Reset) Hedging can be done with both forwards or futures.
What are the differences with using one or the other?
In reality, who generally uses what instuments? |
1) Futures are standardized contracts and forwards are customizeable 2) Futures go through the clearinghouse while forwards have counter party risk 3) Futures are more transparent/regulated and require margin. Has daily settlement of gains and losses. Forward contracts pay off the full value of the contract 4) Public vs private. A) Most bond and equity hedging are done with futures. B) Hedging of interest payments are usually done with forwards because you can customize amounts and dates. C) There is a large market of eurodollar futures but it is used by mostly dealers and market makers. |
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* formulas for options |
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Describe the returns on a covered call and why it is capped |
A covered call is writing a call option while holding the stock itself. You get the upside from the stock itself but it is capped because you have written off the upside potential. Max loss is reduced. Max upside is no longer unlimited. |
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What is a bull spread? |
It is when you buy a call and subsidize the cost of the call with writing an option at a higher exercise price. |
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What does the long part of a Butterfly spread hope the stock price will do? How do you construct a butterfly call spread? How do you do one with calls? (put in later how to calc break even) |
The investor hopes that stock price will stay near the strike price of the written calls. Buy Call: High, Low Sell Call: 2x Med It is done the same way with puts. |
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What is a straddle and how do you create it? |
It is just buy a call and put option at the same exercise price. You only earn money if the stock moves from the exercise price. |
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How do you construct a collar? |
It is a combination of a protective put and covered call. So this implies you WILL hold the underlying. Basically you are selling a call for the premium to buy the put. |
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If all options are priced correctly, what is the rate of return on a Box Spread? |
A box spread is created by combining a bull spread and a bear spread with the same prices. The rate of return must be the risk free rate. |
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What is the formula for amount of futures contracts needed to be hedged? |
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What is the max value for a bjtterfly spread? What are the formulas for the 2 break even prices? |
Note that if Xh is symetrical then it can just be Xh - cost. |
