Lecture 17 Flashcards Preview

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Flashcards in Lecture 17 Deck (36)
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1
Q

Forward =

A

Deferred-delivery sale of asset with the sales price agreed now

2
Q

Futures =

A

Similar to forward but the feature is formalised and standardised by contracts

3
Q

Key differences between forward and future (3)

A
  • Standardised contracts create liquidity
  • Marked to market
  • Exchange mitigates credit risk
4
Q

Futures contract =

A

Obligation to make/ take delivery of an underlying asset at a predetermined price

5
Q

Futures price =

A

Price for underlying asset is determined today, but settlement is at a future date

6
Q

Futures contract specifies

A

Quantity and quality of underlying asset and how it is delivered

7
Q

Long =

A

Commitment to purchase commodity on a delivery date

8
Q

Short =

A

Commitment to sell commodity on delivery date

9
Q

Futures are traded

A

On a margin

10
Q

At the time the contract is entered into

A

No money changes hands

11
Q

Profit to long =

A

Spot price at maturity - original futures price

12
Q

Profit to short =

A

Original futures price - sport price at maturity

13
Q

Futures contract = zero sum game

A

Gains and losses net out to zero

14
Q

Unlike call option, payoff to long position can be negative because

A

Futures trader cannot walk away from the contract if it is not profitable

15
Q

Exchange acts as

A

Clearing house and counter-party to both sides of the trade

16
Q

Net position of a trading house =

A

0

17
Q

Open interest =

A

Number of outstanding contracts

18
Q

If currently in a long position, will instruct trader to

A

Enter short side of contract to close out position

19
Q

Most futures contracts are closed out by

A

Reversing trades

20
Q

Marking to market =

A

Profits/ losses from the new futures price are paid over or subtracted from the account

21
Q

Convergence of price =

A

Movement of the price of a futures contract towards the spot price of the underlying cash commodity as the delivery date approaches. The two prices must converge, or else traders would exploit any price difference to make a risk-free profit

22
Q

Initial margin =

A

Funds/ interest earning securities deposited to provide capital to absorb losses

23
Q

Maintenance margin =

A

Established value below which trader’s margin may not fall

24
Q

Margin call =

A

When the maintenance margin is reached, the broker will ask for additional margin funds

25
Q

Speculators

A

Seek profit from price movements

26
Q

Short

A

Believe the price will fall

27
Q

Long

A

Believe the price will rise

28
Q

Hedgers

A

Seek protection from price movements

29
Q

Long hedge

A

Protecting against a rise in the purchase price

30
Q

Short hedge

A

Protecting against a fall in the selling price

31
Q

Why buy futures contract instead of just underlying asset? (2)

A
  • Lower transaction costs

- Provides leverage

32
Q

Basis =

A

Difference between the futures price and the spot price Ft- Pt

33
Q

Convergence property states that at maturity

A

Ft - Pt = 0

34
Q

Basis risk =

A

Variability in basis means that gains and losses on contract and asset may not perfectly offset if they are liquidated before maturity

35
Q

Spot-Futures parity theorum states there are two ways to acquire asset for a date in the future

A
  • Purchase now and store it

- Take long position in futures

36
Q

With a perfect hedge

A

Futures pay-off = certain therefore no risk, therefore should earn riskless rates of return