11 Questions
What is the main characteristic of a derivative?
Its value is derived from another asset
How do futures and forwards differ from each other?
Futures are traded over the counter while forwards are on exchanges
What is the key difference between a call option and a put option?
The right to buy versus the right to sell
In options trading, what does 'the right but not the obligation' mean for the buyer?
The buyer can choose not to exercise the option if it's not profitable
Which type of derivative contract is customizable and traded over the counter?
Forward
What is the main difference between privately held firms and publicly held firms?
Publicly held firms have an unlimited number of shareholders.
What is the role of an underwriter in the context of securities?
Evaluating and assuming another party's risk.
Which type of firm has fewer obligations to release financial statements to the public?
Privately held firms
What is the primary offering method for privately held firms?
Selling securities to a small group of investors.
When do swaps contracts settle cash flows?
On predetermined dates
What does an underwriter primarily do during risk assessment?
Evaluate the risk associated with a potential policyholder
Study Notes
Derivatives
- A financial instrument whose value is derived from the value of another asset, known as the underlying
- Not a product, but a contract that derives its value from changes in the price of the underlying
- Four major types: Futures, Forwards, Options, and Swaps
Futures
- An agreement between two parties to buy/sell a commodity or financial instrument at a predetermined price on a specified date
- Traded on an exchange, hence standardized
Forwards
- Works similarly to Futures, but traded over the counter and customizable
Options
- Provide the buyer with the right, but not the obligation, to purchase or sell the underlying asset at a predetermined price
- Two types: Call and Put options
- Call option: gives the right to buy a given quantity of the underlying asset at a given price
- Put option: gives the right to sell a given quantity of the underlying asset at a given price
Swaps
- Derivative contracts that allow the exchange of cash flows between two parties
- Settle cash flows on predetermined dates
Public vs. Private Companies
- Privately held firms: owned by individuals or corporations, fewer obligations to release financial statements to the public
- Examples: insurance companies, investment bank funds, pension funds, hedge funds
Publicly Held Firms
- Corporations whose shareholders have a claim to part of the company’s assets and profits
- Securities are sold to the general public, and investors can trade shares
- Has unlimited number of shareholders, obligated to release financial statements to the public
- Sold to the public, often with an underwriter, and registration must be filed with the SEC
Underwriter
- A person or institution that evaluates and assumes another party’s risk
- Roles: risk assessment, decision-making, compliance, documentation review, communication, monitoring, and portfolio management
- Types of underwriters: mortgage underwriter, loan underwriter
Learn about derivatives, a financial instrument whose value is derived from another asset known as the underlying. Explore the four major types of derivative contracts, including futures and forwards.
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