Finance Chapter 5: Derivative Assets

A financial instrument whose value is derived from the price of another asset, such as commodities, stocks, or currencies. They are mainly used for managing risks rather than raising capital.

The position of holding an asset or having the right to receive an asset in the future.

The position of selling an asset or having the obligation to deliver an asset in the future.

A strategy used to manage risk by taking an opposite position to the original one. If you are long, you create a short position to hedge the risk and vice versa.

A contract that obligates two parties to buy or sell an asset at a predetermined price and date.

The current market price of an asset.

The risk associated with changes in interest rates.

The risk associated with changes in exchange rates.

The predetermined price in a forward contract at which the commodity will be bought or sold in the future.

A forward contract used to lock in a price for a financial asset, like a bond, at a future date.

A contract that gives the buyer the right, but not the obligation, to purchase an underlying asset at a predetermined price (exercise price) on or before a specific date.

A contract that gives the buyer the right, but not the obligation, to sell an underlying asset at a predetermined price (exercise price) on or before a specific date.

The profit made from selling a forward contract at a higher price than the initial purchase price.

The profit made from buying a forward contract at a lower price than the initial sale price.

The risk that the counterparty in a forward contract may default or become bankrupt, making it difficult to enforce the contract and potentially leading to financial losses.

The difficulty of finding a counterparty with the same needs and willingness to enter a forward contract, resulting in limited trading opportunities for the asset.

A standardized futures contract that is traded on an organized exchange, with a pre-defined asset, delivery date, and trading unit, allowing for efficient market making.

A financial institution involved in the trading of futures contracts, acting as a central counterparty and ensuring the settlement of trades, reducing counterparty risk.

A requirement for both buyers and sellers of a futures contract to deposit a certain amount of funds as collateral, ensuring the fulfillment of obligations and mitigating default risk.

A process where the margin account of futures contract participants is adjusted daily based on price changes of the underlying asset, ensuring that sufficient collateral is available for potential losses.

A process where the participant in a futures contract with a negative balance is called upon to deposit additional funds to meet the margin requirement.

A financial instrument that gives its holder the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date.

The difference between the option's premium and the profit or loss made on the underlying asset.

A formula used for calculating the price of a European call option.

A portfolio consisting of a stock, a short call option with a strike price equal to the stock's current price, and a long put option with a strike price equal to the stock's current price. It is riskless because the payoffs from the options perfectly offset the payoffs from the stock, resulting in a constant payoff regardless of the stock's price at expiration.

An investment strategy with both a long call and a long put option on the same underlying asset with the same strike price. This strategy benefits when the price of the underlying asset moves significantly, either up or down, while it loses money when the price stays close to the strike price.

A riskless portfolio is a portfolio of financial assets that has a guaranteed return, regardless of the price movement of the underlying assets. It is typically achieved by combining assets in specific proportions, often using derivatives like options.

A straddle is an options trading strategy that involves buying both a call and a put option on the same underlying asset with the same strike price and expiration date. It benefits from large price movements in either direction but loses money if the price stays close to the strike price.

Hedging FX rate risk is a strategy employed to protect against potential losses from fluctuations in exchange rates. It involves taking a position in a financial instrument that offsets the risk associated with the underlying asset.

The payoff to a short position in a forward contract is the difference between the forward price and the spot price at the expiration date, if the spot price is lower.

The payoff to a long position in a forward contract is the difference between the forward price and the spot price at the expiration date, if the spot price is higher.