INTRODUCTION TO DERIVATIVES AND RISK
MANAGEMENT 10TH EDITION FINAL PAPER
FULL SOLUTION STUDY GUIDE
◉ What is a forward contract?
Answer: Forward contracts are privately negotiated (OTC) formal
agreements between two parties in which one party agrees to
purchase an underlying asset from the other party at a certain future
time for a certain price. Whilst they do provide customised terms, as
an OTC transaction they are unregulated and fully dependent on
counterparty so therefore carry credit default risk.
◉ How can a forward contracts be used for hedging against
systematic risk?
Answer: If someone believes there will be an unfavourable future
market change, they can enter a forward contract to lock in a current
price and protect their investment.
◉ What is the risk of a forward contract?
Answer: If the market shifts unfavourably you could lose. Eg if the
foreign currency depreciates over the contract period when buying
then you pay more than you would at market price.
◉ What kind of assets are traded in future contracts?
,Answer: A wide range of commodities such as meat, live cattle,
sugars, wood, gold, currencies, government treasury bonds etc...
◉ What is a future contract?
Answer: A contract which obligates one to buy (long) or sell (short)
an asset at a specific date in the future at a price set today. They take
place in a public market and are actively traded and regulated so
there is no counterparty risk.
◉ What is a swap contract?
Answer: An agreement to end change cash flows in the future
according to a prearranged formula. There are many different types
of swaps such as interest rate swaps, currency swaps and currency
default swaps.
◉ What is an interest rate swap?
Answer: Changing a type of interest rate (fixed) for another (variable
and vice versa) on the same principal payment
◉ What is a currency swap?
Answer: A swap where interest and principal in one currency are
exchanged for a certain notational principal in another currency.
◉ What is a credit default swap?
,Answer: An insurance policy on a financial product that pays a fixed
dollar payoff in the event of a default by a particular company
◉ What are options contracts and their types?
Answer: Options contracts are derivative trading products that
provide the right to buy or sell an underlying asset by a certain date
for a certain price. There are two main types of options, a call option
and a put option.
◉ What is a call option?
Answer: The right to purchase a certain asset by a certain date for a
certain price, that being the exercise or strike price.
◉ What is a put option?
Answer: The right to sell a certain asset by a certain date for a
certain price, that being the exercise or strike price.
◉ What is the difference between European and American options?
Answer: European options can only be exercised at maturity, while
American options can be exercised at any time before expiration.
◉ What does in the money mean?
Answer: You will make profit when you close the contract
, ◉ What does out of the money mean?
Answer: You will lose money/no profit when you close the contract
◉ What does at the money mean?
Answer: Strike price matches the current asset price. Note this does
not mean the investor will necessarily go even
◉ Where are derivatives traded?
Answer: Exchanges such a as ASX, CME etc... and Over the Counter
markets such as workers for banks, fund managers and corporate
treasurers.
◉ Are more derivatives traded over the counter or on exchanges?
Answer: More are traded on exchanges but the average size of OTC
transactions is larger
◉ What is the CCP in contracts?
Answer: A body used to clear standardised OTC transactions
between financial institutions with all trades being required to be
reported to a central repository in some countries.
◉ What is a long position?
Answer: held by the party who wants to buy the
commodity/financial (bullish).
MANAGEMENT 10TH EDITION FINAL PAPER
FULL SOLUTION STUDY GUIDE
◉ What is a forward contract?
Answer: Forward contracts are privately negotiated (OTC) formal
agreements between two parties in which one party agrees to
purchase an underlying asset from the other party at a certain future
time for a certain price. Whilst they do provide customised terms, as
an OTC transaction they are unregulated and fully dependent on
counterparty so therefore carry credit default risk.
◉ How can a forward contracts be used for hedging against
systematic risk?
Answer: If someone believes there will be an unfavourable future
market change, they can enter a forward contract to lock in a current
price and protect their investment.
◉ What is the risk of a forward contract?
Answer: If the market shifts unfavourably you could lose. Eg if the
foreign currency depreciates over the contract period when buying
then you pay more than you would at market price.
◉ What kind of assets are traded in future contracts?
,Answer: A wide range of commodities such as meat, live cattle,
sugars, wood, gold, currencies, government treasury bonds etc...
◉ What is a future contract?
Answer: A contract which obligates one to buy (long) or sell (short)
an asset at a specific date in the future at a price set today. They take
place in a public market and are actively traded and regulated so
there is no counterparty risk.
◉ What is a swap contract?
Answer: An agreement to end change cash flows in the future
according to a prearranged formula. There are many different types
of swaps such as interest rate swaps, currency swaps and currency
default swaps.
◉ What is an interest rate swap?
Answer: Changing a type of interest rate (fixed) for another (variable
and vice versa) on the same principal payment
◉ What is a currency swap?
Answer: A swap where interest and principal in one currency are
exchanged for a certain notational principal in another currency.
◉ What is a credit default swap?
,Answer: An insurance policy on a financial product that pays a fixed
dollar payoff in the event of a default by a particular company
◉ What are options contracts and their types?
Answer: Options contracts are derivative trading products that
provide the right to buy or sell an underlying asset by a certain date
for a certain price. There are two main types of options, a call option
and a put option.
◉ What is a call option?
Answer: The right to purchase a certain asset by a certain date for a
certain price, that being the exercise or strike price.
◉ What is a put option?
Answer: The right to sell a certain asset by a certain date for a
certain price, that being the exercise or strike price.
◉ What is the difference between European and American options?
Answer: European options can only be exercised at maturity, while
American options can be exercised at any time before expiration.
◉ What does in the money mean?
Answer: You will make profit when you close the contract
, ◉ What does out of the money mean?
Answer: You will lose money/no profit when you close the contract
◉ What does at the money mean?
Answer: Strike price matches the current asset price. Note this does
not mean the investor will necessarily go even
◉ Where are derivatives traded?
Answer: Exchanges such a as ASX, CME etc... and Over the Counter
markets such as workers for banks, fund managers and corporate
treasurers.
◉ Are more derivatives traded over the counter or on exchanges?
Answer: More are traded on exchanges but the average size of OTC
transactions is larger
◉ What is the CCP in contracts?
Answer: A body used to clear standardised OTC transactions
between financial institutions with all trades being required to be
reported to a central repository in some countries.
◉ What is a long position?
Answer: held by the party who wants to buy the
commodity/financial (bullish).
