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The payoffs for financial derivatives are linked to
Financial Derivatives include
By hedging Portfolio a bank manager
The markets in which derivatives are traded is known as
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The contract where buyer and seller agrees to exchange asset on future date without the involvement of an exchange
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The contract which gives the buyer the right but not obligation
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The buyer in the derivative contract is also known as
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ETD stands for
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Market players who take benefits from difference in market prices are called
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Short in derivative contract implies
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Which of the following is potentially obligated to sell an asset at a predetermined price
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Which of the following contract is non-standardized and suffers illiquidity most
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The initial amount paid by option buyer at the time of entering the contract
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When the maturity matches but the size of the futures does not match, the hedge can be
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What is the total number of futures/option contracts outstanding at the close of the previous day’s trading?
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Which of the following is a non-variance based model for computation of VaR?
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Who takes the short position in an option contract?
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Which of the following is not used in future pricing?
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Which type of option contract would lead to zero cash flow if exercised immediately?
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Which type of option contract would lead to positive cash flow if exercised immediately?
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The absence of arbitrage between the value of European call and put options with same strike price and expiry date on the same underlying asset is shown by
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What is a swap that takes into consideration daily variation of market rates within a specific range?
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What is a swap that pays a certain fixed amount if the rate is above or below a certain level?
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Study Notes
Financial Derivatives and Risk Management
Financial Derivatives
- Payoffs are linked to underlying assets or securities, such as interest rates, currencies, or commodities.
- Include futures, options, forwards, and swaps.
Futures
- Traded on exchanges, such as NCDEX, NMCE, and MCX.
- Mark-to-market settlement system used.
- Open interest refers to the total number of outstanding contracts.
Options
- Give the buyer the right, but not the obligation, to buy or sell an underlying asset.
- Types: call, put, American, European, and Bermudan options.
- OPTION STRATEGIES:
- Selling one put option at a low strike price and buying a put option at a high strike price is a put bear spread.
- A calendar spread is formed by using options on the same asset with the same strike price but different expiration dates.
Forwards
- Customized contracts between two parties.
- Not traded on exchanges.
- Settlement occurs on the expiration date.
Swaps
- Agreement to exchange cash flows between two parties.
- Types: currency swaps, interest rate swaps, and commodity swaps.
- SWAP FEATURES:
- Callable swap: seller has the chance to terminate the swap at any time before maturity.
- Putable swap: buyer has the chance to terminate the swap at any time before maturity.
Risk Management
- Hedging: reduces risk by taking a position in a futures or options contract to offset potential losses or gains in an underlying asset.
- Types of risk: market risk, liquidity risk, credit risk, and operational risk.
- Value-at-Risk (VaR): estimates the potential loss of a portfolio over a specific time horizon with a given probability.
Option Pricing Models
- Binomial Option Pricing Model: developed by John Cox, Stephen Ross, and Mark Rubinstein.
- Black-Scholes Model: used to estimate the value of options.
Swap Agreements
- Notional principle: the underlying amount in a swap contract.
- LIBOR: London Interbank Offered Rate, used as a reference rate in swap agreements.
Hedging and Speculation
- Hedgers: reduce risk by taking a position in a futures or options contract to offset potential losses or gains in an underlying asset.
- Speculators: take positions in futures or options contracts in anticipation of profit from price movements.
- Arbitrageurs: take advantage of price differences between two markets to earn a risk-free profit.### Types of Swaps
- An accreting swap is a type of swap where one stream of future interest payments is exchanged for another based on a specified principal amount.
- Interest rate swaps are a type of swap where one party exchanges a series of fixed-rate interest payments for a series of floating-rate interest payments.
Futures vs. Forwards
- Futures differ from forwards because they are marked to market daily.
- Futures are used to hedge portfolios, individual securities, and in both financial and foreign exchange markets.
Standardized Futures Contracts
- Standardized futures contracts exist for stock indexes, gold, and Treasury bonds.
- Common stocks are an exception, where standardized futures contracts do not exist.
Roles in Futures Markets
- A pit trader is a type of trader who executes trades on the floor of an exchange.
- A local is a trader who trades for their own account.
- A floor broker is a trader who executes trades for others.
- A futures commission merchant is similar to a stock broker, as they act as an intermediary between buyers and sellers.
Risk Management
- Using futures contracts to transfer price risk is called hedging.
- Hedging involves reducing or eliminating risk by taking a position in a futures contract that is opposite to a current position.
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Test your knowledge of financial derivatives and risk management with this multiple-choice question bank designed for M.Com IV semester students.