Derivative Instruments Module 5
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Questions and Answers

Which of the following is NOT a type of derivative instrument?

  • Forwards
  • Bonds (correct)
  • Futures
  • Options

    • What is the primary purpose of hedging?

  • To speculate on market movements
  • To minimize risk (correct)
  • To maximize profits
  • To create synthetic exposure

    • Futures contracts are always traded on organized exchanges.

    True

    What is NOT a characteristic of forwards contracts?

    <p>Standardized</p> Signup and view all the answers

    Which type of option gives the holder the right to sell the underlying asset at a predetermined price?

    <p>Put Option</p> Signup and view all the answers

    What are the three primary purposes of derivatives?

    <p>Hedging, speculation, and arbitrage.</p> Signup and view all the answers

    What type of spread involves options with the same expiration dates but different strike prices?

    <p>Price Spread</p> Signup and view all the answers

    Derivatives are financial instruments that derive their value from an ______ asset.

    <p>underlying</p> Signup and view all the answers

    Which of the following is NOT a benefit of using derivatives for risk management?

    <p>Eliminates all risks</p> Signup and view all the answers

    What are the two main types of risks that derivatives can magnify?

    <p>Hedging and speculation.</p> Signup and view all the answers

    Arbitrage is a risk-free strategy that involves profiting from price discrepancies in different assets.

    <p>True</p> Signup and view all the answers

    What is NOT a characteristic of futures contracts?

    <p>Traded over-the-counter</p> Signup and view all the answers

    What is the primary difference between futures and forwards contracts?

    <p>Futures are standardized and traded on exchanges, while forwards are customized and traded over-the-counter.</p> Signup and view all the answers

    Derivatives always involve the physical exchange of the underlying asset.

    <p>False</p> Signup and view all the answers

    Which type of swap involves the exchange of one stream of future interest payments for another based on a pre-determined notional principal amount?

    <p>Interest Rate Swap</p> Signup and view all the answers

    What are the two primary benefits of using derivatives for portfolio diversification?

    <p>Access to a wider range of assets and reducing portfolio risk.</p> Signup and view all the answers

    Derivatives can be used to create synthetic exposure to underlying assets without directly owning them.

    <p>True</p> Signup and view all the answers

    Which of the following is NOT a benefit of futures contracts for retail investors?

    <p>Customization</p> Signup and view all the answers

    What are the two primary risks associated with using swaps?

    <p>Higher counterparty risk and less liquidity.</p> Signup and view all the answers

    Options contracts always obligate the holder to buy or sell the underlying asset.

    <p>False</p> Signup and view all the answers

    What type of derivative instrument is utilized to provide insurance against the default of a debt instrument?

    <p>Credit Default Swap</p> Signup and view all the answers

    What is the primary benefit of using derivatives for capital efficiency?

    <p>Reducing the amount of capital required for certain transactions.</p> Signup and view all the answers

    Derivatives are always a suitable investment strategy for all market participants.

    <p>False</p> Signup and view all the answers

    Study Notes

    Module 5: Derivative Instruments

    • Module 5 of the course covers derivative instruments
    • The course is offered by Divine Word College of Calapan
    • The team responsible for the module is Team Three-O
    • Team members include: Aguilar, Tricia S.; Rayos, Crissthe! Mae D.; Remoquin, Kristine Joy A.

    Table of Contents

    • The module includes sections on introduction, learning objectives, discussion of main topics and subtopics, introduction to derivatives, purposes of derivatives, basic options strategies, risk management, conclusions, and references
    • The topics also include futures, forwards, options, and swaps.

    Learning Objectives/Outcomes

    • Identify and describe the fundamental characteristics and functions of futures, forwards, options, and swaps
    • Explain how derivatives are used, including hedging, speculation, and arbitrage, with practical examples
    • Demonstrate the implementation of basic options strategies, including calls, puts, and spread trades
    • Analyze how derivatives can be used to mitigate financial risks in various market conditions

    Introduction

    • Derivative instruments are essential in financial markets for managing risk and enhancing investment opportunities
    • Their value is derived from underlying assets or indices
    • Futures contracts obligate parties to transact an asset at a future date, options provide the right but not the obligation, swaps involve cash flow exchange

    Futures and Forwards

    • Futures contracts are standardized, traded on exchanges, and have fixed contract sizes and delivery dates
    • Futures have daily settlements
    • Forwards are customized and traded OTC
    • Forward contracts don’t have daily settlements, have higher default risk.

    Options

    • Options are financial derivatives that give the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price
    • Call options provide the right to purchase an asset at a set price
    • Put options provide the right to sell an asset at a set price

    Features and Variants

    • Options can be short-term or long-term, convertible securities, warrants, or rights offerings

    Swaps

    • Swaps are derivative contracts where two parties agree to exchange cash flows or financial obligations
    • Examples types of swaps are interest rate swaps, currency swaps, commodity swaps, and credit default swaps (CDS)

    Purposes of Derivatives

    • Hedging to mitigate risk
    • Speculation
    • Arbitrage

    Basic Option Strategies

    • Options strategies like calls, puts, and spreads are used for leveraging market outlooks
    • These strategies have characteristics and risks

    Role of Derivatives in Risk Management

    • Derivatives can be used to hedge against potential losses in underlying assets, interest rates, currency risks, and commodity price risks
    • Derivatives can improve capital allocation, ease international flows, and diversify portfolios.
    • Hedging is a strategy to minimize price risk

    Conclusions

    • Derivatives are crucial instruments in modern financial markets for managing risk, speculation, and arbitrage
    • Includes futures, forwards, options, and swaps.

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    Related Documents

    Module 5: Derivative Instruments PDF

    Description

    This module focuses on derivative instruments, presenting an in-depth examination of futures, forwards, options, and swaps. You will learn their characteristics, purposes, and basic strategies for implementing options in financial scenarios. This knowledge is essential for understanding risk management and practical applications in finance.

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