Derivatives Exam(complete)2022
Why are derivatives an effective risk management tool to make riskless profit? 1.) Derivative contracts hedge risks (offset losses) 2.) Use derivatives and spot prices to estimate the future price of an asset 3.) High volatility of stock prices (taking a gamble and there's always the risk of default) 4.) timing is an important factor What is a derivative? -A financial instrument whose price depends on the underlying asset (option depends on stock or bond, etc.) 00:03 00:54 No arbitrage The inability to make a profit without taking risk. make your portfolio riskless (risk-free rate) What is a risk neutral investor? one who does not care for the risk and does not require a risk premium to invest in a risky asset. only expects risk-free rate back What is a risk-seeking investor ? one who does who is ready to take a negative risk premium and prefers risky securities than riskless securities with the same return. What is a risk-averse? someone that does not accept the risk without expecting some additional return for that risk. When a derivative can be combined with and asset. what can it produce? a risk-free position. What is a derivative price? the price that guarantees the risk-free combination of the derivative and the underlying to produce a risk-free rate of return What else do they call derivatives pricing? risk-neutral pricing. What is not a factor in determining the derivative price? The investor's risk-aversion What does risk-neutral pricing mean? This means the expected payoff of the derivative can be discounted at the risk-free rate rather than the risk-free rate plus a risk premium. What are the limits to arbitrage? Transaction costs, inability to short-sell, inability to borrow unlimited money at the risk-free rate, and money put into margin accounts (initial margin and maintenance margin)
Document information
- Uploaded on
- September 5, 2022
- Number of pages
- 9
- Written in
- 2022/2023
- Type
- Exam (elaborations)
- Contains
- Questions & answers
