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