FINA 471 Exam 1

Speculator

A ____ takes more risk in the hope of making profits; helps risk sharing and price discovery

Foreign currency

A _____ is like a security providing a dividend yield

Hedger

A _____ uses derivatives to offset the exposure to some other position

Option

A(n) ____ always has a positive value

Exchanges trading futures/options

CME group, EUREX, NYSE Euronext Group, and Chicago Board Options Exchange are examples of

Stock indices

Dow Jones, S&P 500, NASDAQ 100 indices are examples of _____

Features of futures contracts

Examples of _____: exchange trade forward contracts; standardized with specific delivery dates, locations; guaranteed by clearing house; gains/losses settled daily; margin required as collateral

Limitations of forward contracts

Examples of _____: liquidity and counterparty risk

forward contract

Features/quantity of an asset to be delivered, the "expiration date", and the "forward price" are all specified by a _______

Payoff on sort position

Forward price minus spot price at expiration

storage costs

Holding an asset may incur _____; negative income

Correlation

If _____ is low, futures is not an effective hedge, so one should be more conservative in taking futures position

Cash flows occur at multiple times

In zero-coupon bonds, interest rates do not define a discount rate for a specific time because cash flows occur at multiple times

Uses of derivatives

Risk management (hedging), speculation, and arbitrage are all examples of the ________

Payoff on long position

Spot price at expiration minus forward price

continuous dividend yield

The ____ is the continuously compounded foreign risk-free interest rate

Spot price

The ____ is the present value of the forward price

Greater than

The notional value of the OTC is _______ than the exchange notional value

a short position

The party who buys has _____

a long position

The party who buys has ______

Consumption Assets

___ are assets held primarily for consumption

Futures contracts

___ are the same as forward contracts in principal except for some institutional and pricing differences

European option

___ can be exercised only at maturity

Future price of stock indices

___ can be viewed as an investment asset paying a dividend yield

Short hedge

___ is appropriate when you know you will sell an asset in the future and want to lock in the price

Basis Risk

____ arises because of date mismatching, asset mismatching

American Option

____ can be exercised anytime during life

Option contract

____ gives the holder the right (but NOT the obligation) to buy/sell at a certain strike price

Long hedge

____ is appropriate when you know you will buy an asset in the future and want to lock in the price

Investment assets

_____ are assets held by significant numbers of people purely for investment purposes

forward/futures contract

______ has zero value when initiated

Call option

a ____ is an option to buy a certain asset by a certain date for a certain price

Forward Contracts

a binding agreement to buy/sell an underlying asset at a predetermined date in the future, at a price set today

What is a derivative?

a financial instrument whose value depends on the value of other more basic underlying variables such as: stock price, interest rate, foreign exchange rate, commodity prices, house price index, and weather conditions

Offsetting trade

a majority of futures are closed out before maturity by an _____

Maintenance Margin

a margin call is issued if account balance falls below the _____

Futures

a standardized forward contract traded on exchanges

Over the Counter (OTC) market

a telephone and computer-linked network of dealers; financial institutions often act as market makers

Interest Rate Compounding

adding accrued interest and compounding frequency

Initial Margin

amount to be deposited when entering into a contract

Forward

an agreement to buy or sell an asset in the future contract traded on exchanges

Swaps

an agreement to exchange cash flows at specified future times - can be viewed as a package of forward contracts

Options

an instrument that conveys the right (for the holder), but NOT the obligation, to engage in a future transactions

Put option

an option to sell a certain asset by a certain date for a certain price

Producer's Perspective

as if having a long position, hedged by entering into short position, gets rid of pricing uncertainty

Speculation

bet on the future direction of the market

Zero-Coupon Bonds

bonds with no payment before maturity

Marking to Market

daily loss/gain enters into the margin account at the end of each trading day

Over the Counter (OTC) market

forwards are traded in the ______

Arbitrage

getting something out of nothing, usually by creating 2 portfolios with identical cash flows and profit from the price differences

Forward/futures contract

gives holder the right AND obligation to buy/sell at a certain price

Cross Hedging

hedging an exposure to the price of one asset with the contract on another asset

Treasury Rates

interest rates an investor earned on treasury securities

LIBOR Rates

interest rates at which banks offer to lend unsecured short-term funds to other banks in the London interbank market

Arbitrageur

lock in riskless profits by simultaneously entering into transactions in two or more markets; makes asset prices in line with each other

Advantages to stock indices compared to direct stock purchase

lower transaction costs, takes less time to acquire are examples of

Settlement Price

price at which a contract traded just before the final bell of each day

Optimal Hedge Ratio

ratio of the size of the position taken in futures contracts to the size of the original exposure

Stock index

the (possibly scaled) value of a hypothetical portfolio of stocks

Basis

the difference between the spot and futures price (St - Ft)

Value at expiration

the payoff on a forward contract is its ______

Basis Risk

uncertainty associated with basis

Stock index

used to track movement of overall market or some specific market sectors