Derivatives & Alternative Investments

Fixed for floating swap

An interest rate swap in which one party pays a fixed rate and the other pays a floating rate, with both sets of payments in the same currency. Also called plain vanilla swap or vanilla swap.

Settlement price

The official price, designated by the clearinghouse, from which daily gains and losses will be determined and marked to market.

Locked limit

A condition in the futures markets in which a transaction cannot take place because the price would be beyond the limits.

Credit spread option

An option on the yield spread on a bond.

European style option

An option that can be exercised only on the expiration date

Which of the following is the best example of a derivative? A) A global equity mutual fund B) non-callable government bond C) A contract to purchase Apple Computer at a fixed price

C

Spot Market

Market in which assets are traded for immediate delivery

Forward Commitment

Class of derivatives that provides the ability to lock in a price to transact in the future at a previously agreed-upon price. Examples include forward contracts, futures & swaps.

Leveraged buyout

(LBO) A transaction whereby the target company management team converts the target to a privately held company by using heavy borrowing to finance the purchase of the target company's outstanding shares.

Management buyout

(MBO) A leveraged buyout event in which a group of investors consisting primarily of the company's existing management purchase at least controlling interest of its outstanding shares. They may purchase all shares and take the company private.

1. A derivative is best described as a financial instrument that derives its performance by: A. passing through the returns of the underlying. B. replicating the performance of the underlying. C. transforming the performance of the underlying.

1. C is correct. A derivative is a financial instrument that transforms the performance of the underlying. The transformation of performance function of derivatives is what distinguishes it from mutual funds and exchange traded funds that pass through the returns of the underlying. A is incorrect because derivatives, in contrast to mutual funds and exchange traded funds, do not simply pass through the returns of the underlying at payout. B is incorrect because a derivative transforms rather than replicates the performance of the underlying.

10. A credit derivative is a derivative contract in which the: A. clearinghouse provides a credit guarantee to both the buyer and the seller. B. seller provides protection to the buyer against the credit risk of a third party. C. the buyer and seller provide a performance bond at initiation of the contract.

10. B is correct. A credit derivative is a derivative contract in which the credit protection seller provides protection to the credit protection buyer against the credit risk of a third party. A is incorrect because the clearinghouse provides a credit guarantee to both the buyer and the seller of a futures contract, whereas a credit derivative is between two parties, in which the credit protection seller provides a credit guarantee to the credit protection buyer. C is incorrect because futures contracts require that both the buyer and the seller of the futures contract provide a cash deposit for a portion of the futures transaction into a margin account, often referred to as a performance bond or good faith deposit.

11. Compared with the underlying spot market, derivative markets are more likely to have: A. greater liquidity. B. higher transaction costs. C. higher capital requirements.

11. A is correct. Derivative markets typically have greater liquidity than the underlying spot market as a result of the lower capital required to trade derivatives compared with the underlying. Derivatives also have lower transaction costs and lower capital requirements than the underlying. B is incorrect because transaction costs for derivatives are lower than the underlying spot market. C is incorrect because derivatives markets have lower capital requirements than the underlying spot market.

12. Which of the following characteristics is least likely to be a benefit associated with using derivatives? A. More effective management of risk B. Payoffs similar to those associated with the underlying C. Greater opportunities to go short compared with the spot market

12. B is correct. One of the benefits of derivative markets is that derivatives create trading strategies not otherwise possible in the underlying spot market, thus providing opportunities for more effective risk management than simply replicating the payoff of the underlying. A is incorrect because effective risk management is one of the primary purposes associated with derivative markets. C is incorrect because one of the operational advantages associated with derivatives is that it is easier to go short compared to the underlying spot market.

13. Which of the following is most likely to be a destabilizing consequence of speculation using derivatives? A. Increased defaults by speculators and creditors B. Market price swings resulting from arbitrage activities C. The creation of trading strategies that result in asymmetric performance

13. A is correct. The benefits of derivatives, such as low transaction costs, low capital requirements, use of leverage, and the ease in which participants can go short, also can result in excessive speculative trading. These activities can lead to defaults on the part of speculators and creditors. B is incorrect because arbitrage activities tend to bring about a convergence of prices to intrinsic value. C is incorrect because asymmetric performance is not itself destabilizing.

14. The law of one price is best described as: A. the true fundamental value of an asset. B. earning a risk-free profit without committing any capital. C. two assets that will produce the same cash flows in the future must sell for equivalent prices.

14. C is correct. The law of one price occurs when market participants engage in arbitrage activities so that identical assets sell for the same price in different markets.

2. Compared with exchange-traded derivatives, over-the-counter derivatives would most likely be described as: A. standardized. B. less transparent. C. more transparent.

2. B is correct. Over-the counter-derivatives markets are customized and mostly unregulated. As a result, over-the-counter markets are less transparent in comparison with the high degree of transparency and standardization associated with exchange-traded derivative markets. A is incorrect because exchange-traded derivatives are standardized, whereas over-the counter derivatives are customized. C is incorrect because exchange-traded derivatives are characterized by a high degree of transparency because all transactions are disclosed to exchanges and regulatory agencies, whereas over-the-counter derivatives are relatively opaque.

3. Exchange-traded derivatives are: A. largely unregulated. B. traded through an informal network. C. guaranteed by a clearinghouse against default.

3. C is correct. Exchanged-traded derivatives are guaranteed by a clearinghouse against default. A is incorrect because traded derivatives are characterized by a relatively high degree of regulation. B is incorrect because the terms of exchange-traded derivatives terms are specified by the exchange.

4. Which of the following derivatives is classified as a contingent claim? A. Futures contracts B. Interest rate swaps C. Credit default swaps

4. C is correct. A credit default swap (CDS) is a derivative in which the credit protection seller provides protection to the credit protection buyer against the credit risk of a separate party. CDS are classified as a contingent claim. A is incorrect because futures contracts are classified as forward commitments. B is incorrect because interest rate swaps are classified as forward commitments.

5. In contrast to contingent claims, forward commitments provide the: A. right to buy or sell the underlying asset in the future. B. obligation to buy or sell the underlying asset in the future. C. promise to provide credit protection in the event of default.

5. B is correct. Forward commitments represent an obligation to buy or sell the underlying asset at an agreed upon price at a future date. A is incorrect because the right to buy or sell the underlying asset is a characteristic of contingent claims, not forward commitments. C is incorrect because a credit default swap provides a promise to provide credit protection to the credit protection buyer in the event of a credit event such as a default or credit downgrade and is classified as a contingent claim.

6. Which of the following derivatives provide payoffs that are non-linearly related to the payoffs of the underlying? A. Options B. Forwards C. Interest-rate swaps

6. A is correct. Options are classified as a contingent claim which provides payoffs that are non-linearly related to the performance of the underlying. B is incorrect because forwards are classified as a forward commitment, which provides payoffs that are linearly related to the performance of the underlying. C is incorrect because interest-rate swaps are classified as a forward commitment, which provides payoffs that are linearly related to the performance of the underlying.

7. An interest rate swap is a derivative contract in which: A. two parties agree to exchange a series of cash flows. B. the credit seller provides protection to the credit buyer. C. the buyer has the right to purchase the underlying from the seller.

7. A is correct. An interest rate swap is defined as a derivative in which two parties agree to exchange a series of cash flows: One set of cash flows is variable, and the other set can be variable or fixed. B is incorrect because a credit derivative is a derivative contract in which the credit protection seller provides protection to the credit protection buyer. C is incorrect because a call option gives the buyer the right to purchase the underlying from the seller.

8. Forward commitments subject to default are: A. forwards and futures. B. futures and interest rate swaps. C. interest rate swaps and forwards.

8. C is correct. Interest rate swaps and forwards are over-the-counter contracts that are privately negotiated and are both subject to default. Futures contracts are traded on an exchange, which provides a credit guarantee and protection against default. A is incorrect because futures are exchange-traded contracts which provide daily settlement of gains and losses and a credit guarantee by the exchange through its clearinghouse. B is incorrect because futures are exchange-traded contracts which provide daily settlement of gains and losses and a credit guarantee by the exchange through its clearinghouse.

9. Which of the following derivatives is least likely to have a value of zero at initiation of the contract? A. Futures B. Options C. Forwards

9. B is correct. The buyer of the option pays the option premium to the seller of the option at the initiation of the contract. The option premium represents the value of the option, whereas futures and forwards have a value of zero at the initiation of the contract. A is incorrect because no money changes hands between parties at the initiation of the futures contract, thus the value of the futures contract is zero at initiation. C is incorrect because no money changes hands between parties at the initiation of the forward contract, thus the value of the forward contract is zero at initiation.

Which of the following statements about derivatives is not true? A) They are created in the spot market. B) They are used in the practice of risk management. C) They take their values from the value of something else

A

Margin Bond

A cash deposit required by the clearinghouse from the participants to a contract to provide a credit guarantee. Also called a performance bond.

Credit derivative

A contract in which one party has the right to claim a payment from another party in the event that a specific credit event occurs over the life of the contract.

Option

A financial instrument that gives one party the right, but not the obligation, to buy or sell an underlying asset from or to another party at a fixed price over a specific period of time. Also referred to as contingent claim or option contract.

Forward Contract

A forward contract is an over-the-counter derivative contract in which two parties agree that one party, the buyer, will purchase an underlying asset from the other party, the seller, at a later date at a fixed price they agree on when the contract is signed.

Futures contract

A futures contract is a standardized derivative contract created and traded on a futures exchange in which two parties agree that one party, the buyer, will purchase an underlying asset from the other party, the seller, at a later date and at a price agreed on by the two parties when the contract is initiated and in which there is a daily settling of gains and losses and a credit guarantee by the futures exchange through its clearinghouse.

Which of the following is not a characteristic of a call option on a stock? A) A guarantee that the stock will increase B) A specified date on which the right to buy expires C) A fixed price at which the call holder can buy the stock.

A is correct. A call option on a stock provides no guarantee of any change in the stock price. It has an expiration date, and it provides for a fixed price at which the holder can exercise the option, thereby purchasing the stock.

What is the most significant drawback of a repeat sales index to measure returns to real estate? A. Sample selection bias B. Understatement of volatility C. Reliance on subjective appraisals

A is correct. A repeat sales index uses the changes in price of repeat-sale properties to construct the index. Sample selection bias is a significant drawback because the properties that sell in each period vary and may not be representative of the overall market the index is meant to cover. The properties that transact are not a random sample and may be biased toward properties that changed in value. Understated volatility and reliance on subjective appraisals by experts are drawbacks of an appraisal index.

Relative to traditional investments, alternative investments are least likely to be characterized by: A. high levels of transparency. B. limited historical return data. C. significant restrictions on redemptions.

A is correct. Alternative investments are characterized as typically having low levels of transparency.

An option provides which of the following? A) Either the right to buy or the right to sell an underlying B) The right to buy and sell, with the choice made at expiration C) The obligation to buy or sell, which can be converted into the right to buy or sell.

A is correct. An option is strictly the right to buy (a call) or the right to sell (a put). It does not provide both choices or the right to convert an obligation into a right.

15. Arbitrage opportunities exist when: A. two identical assets or derivatives sell for different prices. B. combinations of the underlying asset and a derivative earn the risk-free rate. C. arbitrageurs simultaneously buy takeover targets and sell takeover acquirers.

A is correct. Arbitrage opportunities exist when the same asset or two equivalent combinations of assets that produce the same results sell for different prices. When this situation occurs, market participants would buy the asset in the cheaper market and simultaneously sell it in the more expensive market, thus earning a riskless arbitrage profit without committing any capital. B is incorrect because it is not the definition of an arbitrage opportunity. C is incorrect because it is not the definition of an arbitrage opportunity.

Which of the following is not an advantage of derivative markets? A) They are less volatile than spot markets. B) They facilitate the allocation of risk in the market. C) They incur lower transaction costs than spot markets.

A is correct. Derivative markets are not by nature more or less volatile than spot markets. They facilitate risk allocation by making it easier and less costly to transfer risk, and their transaction costs are lower than those of spot markets.

Which of the following responds to the criticism that derivatives can be destabilizing to the underlying market? A) Market crashes and panics have occurred since long before derivatives existed. B) Derivatives are sufficiently regulated that they cannot destabilize the spot market. C) The transaction costs of derivatives are high enough to keep their use at a minimum level.

A is correct. Derivatives regulation is not more and is arguably less than spot market regulation, and the transaction costs of derivatives are not a deterrent to their use; in fact, derivatives are widely used. Market crashes and panics have a very long history, much longer than that of derivatives.

Which of the following characterizes forward contracts and swaps but not futures? A) They are customized. B) They are subject to daily price limits. C) Their payoffs are received on a daily basis.

A is correct. Forwards and swaps are OTC contracts and, therefore, are customized. Futures are exchange traded and, therefore, are standardized. Some futures contracts are subject to daily price limits and their payoffs are received daily, but these characteristics are not true for forwards and swaps.

Compared with traditional investments, alternative investments are more likely to have: A. greater use of leverage. B. long-only positions in liquid assets. C. more transparent and reliable risk and return data.

A is correct. Investing in alternative investments is often pursued through such special vehicles as hedge funds and private equity funds, which have flexibility to use leverage. Alternative investments include investments in such assets as real estate, which is an illiquid asset, and investments in such special vehicles as private equity and hedge funds, which may make investments in illiquid assets and take short positions. Obtaining information on strategies used and identifying reliable measures of risk and return are challenges of investing in alternatives.

Both event-driven and macro hedge fund strategies use: A. long-short positions. B. a top-down approach. C. long-term market cycles.

A is correct. Long-short positions are used by both types of hedge funds to potentially profit from anticipated market or security moves. Event-driven strategies use a bottom-up approach and seek to profit from short-term events typically involving a corporate action, such as an acquisition or a restructuring. Macro strategies seek to profit from expected movements in evolving economic variables.

Hedge fund losses are most likely to be magnified by a: A. margin call. B. lockup period. C. redemption notice period.

A is correct. Margin calls can magnify losses. To meet the margin call, the hedge fund manager may be forced to liquidate a losing position in a security, which, depending on the position size, could exert further price pressure on the security, resulting in further losses. Restrictions on redemptions, such as lockup and notice periods, may allow the manager to close positions in a more orderly manner and minimize forced-sale liquidations of losing positions.

Hedge funds are similar to private equity funds in that both: A. are typically structured as partnerships. B. assess management fees based on assets under management. C. do not earn an incentive fee until the initial investment is repaid.

A is correct. Private equity funds and hedge funds are typically structured as partnerships where investors are limited partners (LP) and the fund is the general partner (GP). The management fee for private equity funds is based on committed capital whereas for hedge funds the management fees are based on assets under management. For most private equity funds, the general partner does not earn an incentive fee until the limited partners have received their initial investment back.

An investor is most likely to consider adding alternative investments to a traditional investment portfolio because: A. of their historically higher returns. B. of their historically lower standard deviation of returns. C. their inclusion is expected to reduce the portfolio's Sharpe ratio.

A is correct. The historically higher returns to most categories of alternative investments compared with traditional investments result in potentially higher returns to a portfolio containing alternative investments. The less than perfect correlation with traditional investments results in portfolio risk (standard deviation) being less than the weighted average of the standard deviations of the investments. This has potential to increase the Sharpe ratio in spite of the historically higher standard deviation of returns of most categories of alternative investments.

The first stage of financing at which a venture capital fund most likely invests is the: A. seed stage. B. mezzanine stage. C. angel investing stage.

A is correct. The seed stage supports market research and product development and is generally the first stage at which venture capital funds invest. The seed stage follows the angel investing stage. In the angel investing stage, funds are typically provided by individuals (often friends or family), rather than a venture capital fund, to assess an idea's potential and to transform the idea into a plan. Mezzanine-stage financing is provided by venture capital funds to prepare the portfolio company for its IPO.

Alternative investment funds are typically managed: A. actively. B. to generate positive beta return. C. assuming that markets are efficient.

A is correct. There are many approaches to managing alternative investment funds but typically these funds are actively managed.

An investor seeks a current income stream as a component of total return, and desires an investment that historically has low correlation with other asset classes. The investment most likely to achieve the investor's goals is: A. timberland. B. collectibles. C. commodities.

A is correct. Timberland offers an income stream based on the sale of timber products as a component of total return and has historically generated returns not highly correlated with other asset classes.

Limit up

A limit move in the futures market in which the price at which a transaction would be made is at or above the upper limit.

Margin call

A request for the short to deposit additional funds to bring their balance up to the initial margin.

Clawback

A requirement that the general partner return any funds distributed as incentive fees until the limited partners have received back their initial investment and a percentage of the total profit.

Collateralised Mortgage Obligation

A security created through the securitization of a pool of mortgage-related products (mortgage pass-through securities or pools of loans).

Total return swap

A swap in which one party agrees to pay the total return on a security. Often used as a credit derivative, in which the underlying is a bond.

Swaps

A swap is an over-the-counter derivative contract in which two parties agree to exchange a series of cash flows whereby one party pays a variable series that will be determined by an underlying asset or rate and the other party pays either (1) a variable series determined by a different underlying asset or rate or (2) a fixed series.

Credit default swap

A type of credit derivative in which one party, the credit protection buyer who is seeking credit protection against a third party, makes a series of regularly scheduled payments to the other party, the credit protection seller. The seller makes no payments until a credit event occurs.

Underlying

An asset that trades in a market in which buyers and sellers meet, decide on a price, and the seller then delivers the asset to the buyer and receives payment. The underlying is the asset or other derivative on which a particular derivative is based. The market for the underlying is also referred to as the spot market m.

Which of the following is not a characteristic of a derivative? A) An underlying B) low degree of leverage C) Two parties—a buyer and a seller.

B

The potential benefits of allocating a portion of a portfolio to alternative investments include: A. ease of manager selection. B. improvement in portfolio risk-return. C. accessible and reliable measures of risk and return.

B is correct. Adding alternative investments to a portfolio may provide diversification benefits because of these investments' less than perfect correlation with other assets in the portfolio. As a result, allocating a portion of one's funds to alternatives could potentially result in an improved risk-return relationship. Challenges to allocating a portion of a portfolio to alternative investments include obtaining reliable measures of risk and return as well as selecting portfolio managers for the alternative investments.

• An investor is seeking an investment that can take long and short positions, may use multi-strategies, and historically exhibits low correlation with a traditional investment portfolio. The investor's goals will be best satisfied with an investment in: A. real estate. B. a hedge fund. C. a private equity fund.

B is correct. Hedge funds may use a variety of strategies (event-driven, relative value, macro and equity hedge), generally have a low correlation with traditional investments, and may take long and short positions.

Which of the following pieces of information is not conveyed by at least one type of derivative? A) The volatility of the underlying B) The most widely used strategy of the underlying C) The price at which uncertainty in the underlying can be eliminated.

B is correct. Options do convey the volatility of the underlying, and futures, forwards, and swaps convey the price at which uncertainty in the underlying can be eliminated. Derivatives do not convey any information about the use of the underlying in strategies.

Which of the following statements most accurately describes exchange-traded derivatives relative to over-the-counter derivatives? Exchange-traded derivatives are more likely to have: A) greater credit risk. B) Standardised contract terms. C) greater risk management uses l.

B is correct. Standardization of contract terms is a characteristic of exchange-traded derivatives. A is incorrect because credit risk is well-controlled in exchange markets. C is incorrect because the risk management uses are not limited by being traded over the counter.

Private equity funds are most likely to use: A. merger arbitrage strategies. B. leveraged buyouts. C. market-neutral strategies.

B is correct. The majority of private equity activity involves leveraged buyouts. Merger arbitrage and market neutral are strategies used by hedge funds.

A credit derivative is which of the following? A) A derivative in which the premium is obtained on credit B) A derivative in which the payoff is borrowed by the seller C) A derivative in which the seller provides protection to the buyer against credit loss from a third party

C is correct. Credit derivatives provide a guarantee against loss caused by a third party's default. They do not involve borrowing the premium or the payoff.

Which of the following distinguishes forwards from swaps? A) Forwards are OTC instruments, whereas swaps are exchange traded. B) Forwards are regulated as futures, whereas swaps are regulated as securities. C) Swaps have multiple payments, whereas forwards have only a single payment.

C is correct. Forwards and swaps are OTC instruments and both are regulated as such. Neither is regulated as a futures contract or a security. A swap is a series of multiple payments at scheduled dates, whereas a forward has only one payment, made at its expiration date.

An investor may prefer a single hedge fund to a fund of funds if he seeks: A. due diligence expertise. B. better redemption terms. C. a less complex fee structure.

C is correct. Hedge funds of funds have multi-layered fee structures, while the fee structure for a single hedge fund is less complex. Funds of funds presumably have some expertise in conducting due diligence on hedge funds and may be able to negotiate more favorable redemption terms than could an individual investor in a single hedge fund.

Which of the following is least likely to be considered an alternative investment? A. Real estate B. Commodities C. Long-only equity funds

C is correct. Long-only equity funds are typically considered traditional investments and real estate and commodities are typically classified as alternative investments.

Which of the following occurs in the daily settlement of futures contracts? A) Initial margin deposits are refunded to the two parties. B) Gains and losses are reported to other market participants. C) Losses are charged to one party and gains credited to the other.

C is correct. Losses and gains are collected and distributed to the respective parties. There is no specific reporting of these gains and losses to anyone else. Initial margin deposits are not refunded and, in fact, additional deposits may be required.

Market makers earn a profit in both exchange and over-the-counter derivatives markets by: A) charging a commission on each trade. B) a combination of commissions and markups. C) buying at one price, selling at a higher price, and hedging any risk.

C is correct. Market makers buy at one price (the bid), sell at a higher price (the ask), and hedge whatever risk they otherwise assume. Market makers do not charge a commission. Hence, A and B are both incorrect.

Which of the following characteristics is associated with over-the-counter derivatives? A) Trading occurs in a central location. B) They are more regulated than exchange-listed derivatives. C) They are less transparent than exchange-listed derivatives.

C is correct. OTC derivatives have a lower degree of transparency than exchange-listed derivatives. Trading does not occur in a central location but, rather, is quite dispersed. Although new national securities laws are tightening the regulation of OTC derivatives, the degree of regulation is less than that of exchange-listed derivatives.

Which of the following characteristics is not associated with exchange-traded derivatives? A) Margin or performance bonds are required. B) The exchange guarantees all payments in the event of default. C) All terms except the price are customized to the parties' individual needs.

C- determines the terms of the contract except the price. The exchange guarantees against default and requires margins or performance bonds.

Contracts for Difference

Cash-settled forward contracts, used predominately with respect to foreign exchange forwards. Also called contracts for differences.

Mezzanine financing

Debt or preferred shares with a relationship to common equity resulting from a feature such as attached warrants or conversion options. Mezzanine financing is subordinate to both senior and high-yield debt. It is referred to as mezzanine because of its location on the balance sheet.

Contingent claims

Derivatives in which the payoffs occur if a specific event occurs; generally referred to as options.

Credit linked note

Fixed-income security in which the holder of the security has the right to withhold payment of the full amount due at maturity if a credit event occurs.

Alternative Investment Characteristics

Illiquidity of underlying investments Narrow manager specialization Low correlation of returns with those of traditional investments Less regulation and less transparency than traditional investments Limited and potentially problematic historical risk and return data Unique legal and tax considerations.

Distressed investing

Investing in securities of companies in financial difficulties. Private equity funds that specialize in distressed investing typically buy the debt of mature companies in financial difficulties.

Venture capital

Investments that provide "seed" or start-up capital, early-stage financing, or later-stage financing (including mezzanine-stage financing) to companies that are in early development stages and require additional capital for expansion or preparation for an initial public offering.

Management buy in

Leveraged buyout in which the current management team is being replaced and the acquiring team will be involved in managing the company.

Price limits

Limits imposed by a futures exchange on the price change that can occur from one day to the next.

Law of one price

The condition in a financial market in which two equivalent financial instruments or combinations of financial instruments can sell for only one price. Equivalent to the principle that no arbitrage opportunities are possible.

American Style Option

Said of an option contract that can be exercised at any time up to the option's expiration date.

Option premium

The amount of money a buyer pays and seller receives to engage in an option transaction.

Margin

The amount of money that a trader deposits in a margin account. The term is derived from the stock market practice in which an investor borrows a portion of the money required to purchase a certain amount of stock. In futures markets, there is no borrowing so the margin is more of a down payment or performance bond.

Committed capital

The amount that the limited partners have agreed to provide to the private equity fund.

exercise (strike) price

The fixed price at which an option holder can buy or sell the underlying. Also called strike price, striking price, or strike.

Forward Price

The fixed price or rate at which the transaction scheduled to occur at the expiration of a forward contract will take place. This price is agreed on at the initiation date of the contract.

Maintenance margin

The minimum amount that is required by a futures clearinghouse to maintain a margin account and to protect against default. Participants whose margin balances drop below the required maintenance margin must replenish their accounts.

Spot Prices

The price of an asset for immediately delivery.

Clearing

The process by which the exchange verifies the execution of a transaction and records the participants' identities.

Risk Management

The process of identifying the level of risk an entity wants, measuring the level of risk the entity currently has, taking actions that bring the actual level of risk to the desired level of risk, and monitoring the new actual level of risk so that it continues to be aligned with the desired level of risk.

Settlement

The process that occurs after a trade is completed, the securities are passed to the buyer, and payment is received by the seller.

Mark to market

The revaluation of a financial asset or liability to its current market value or fair value.

Implied volatility

The volatility that option traders use to price an option, implied by the price of the option and a particular option-pricing model.

Characteristics of attractive LBO targets

Undervalued stock price Willing management & shareholders Inefficient companies Strong cash flow Low leverage Assets (can be used as security to debt)

Derivatives

financial instruments whose prices are derived from the value of some underlying asset.