Flashcards: Introduction to Derivatives and Hedging — 22 cards

Derivative — definition?

A contract whose value depends on an underlying asset.

Forward contract — role?

Obligation to buy or sell at a future date.

Futures contract — function?

Exchange-traded standardized forward settled daily.

Options contract — role?

Gives holder right but not obligation to buy/sell.

Call option — right?

Right to buy at strike K.

Put option — right?

Right to sell at strike K.

Long forward payoff — formula?

S_T − F_0.

Short forward payoff — formula?

F_0 − S_T.

Forward arbitrage — mechanism?

Buy spot, sell forward if overpriced.

Futures clearinghouse — benefit?

Eliminates credit risk via daily settlement.

Margin call — trigger?

When margin falls below maintenance margin.

Mark-to-market — process?

Daily revaluation of futures positions.

Basis risk — definition?

Hedging error from basis change.

Basis — formula?

S − F.

Cross hedging — purpose?

Hedge with different but related asset.

Hedge ratio h* — calculation?

ρ × (σ_S/σ_F).

Equity hedge — goal?

Reduce systematic market risk.

Target beta β* — meaning?

Hedged portfolio beta after adjustment.

Intrinsic value — formula?

max(S−K,0) for calls, max(K−S,0) for puts.

Time value — formula?

Option premium minus intrinsic value.

Protective put — purpose?

Insure against downside risk.

Breakeven — call?

K + premium.