FINC306 Questions and Answers

Define Derivarive Ans- a financial instrument that has a value determined by the value of something else (underlying) Examples of Derivatives Ans- Stocks, bonds, commodities, currencies, interest rates Types of Derivatives Ans- Forwards, futures, options, swaps Why use derivatives Ans- Risk management Speculation Reduce transaction costs Regulatory Arbitrage Difference between Market value and Notional value Ans- market value is the sum of the market value of all the claims that could be traded notional value measures the scale of a position, usually with reference to some underlying asset Define Forward contract Ans- A binding agreement (obligation) to buy or sell an underlying asset in the future, at a price set today Payoff of Forward (long) Ans- Vt = ST - FtT Payoff of Forward (short) Ans- Vt = FtT - ST Today, 2 parties enter a 1 year forward contract to buy and sell a stock. The current price of the stock is St = 90. The agreed forward price is FtT = 100. In 1 year the spot price is ST = 110. What is the payoff of the long position? Ans- VT = ST - FtT VT = 110 - 100 VT = 10 Today, 2 parties enter a 1 year forward contract to buy and sell a stock. The current price of the stock is St = 90. The agreed forward price is FtT = 100. In 1 year the spot price is ST = 1