A contract whose value depends on an underlying asset
Explication
A derivative derives its value from an underlying asset and transfers risk between parties. It does not create value independently of the underlying.
It is exchange-traded and settled daily through a clearinghouse
Explication
Futures are standardized exchange-traded contracts that are marked to market daily through a clearinghouse. Forwards are OTC agreements settled at maturity.
Borrow to buy the spot asset and sell the forward
Explication
This is cash-and-carry arbitrage: borrow, buy spot, and sell the expensive forward. The locked-in profit comes from the gap between the market forward price and fair value.
64 per ounce
Explication
Fair value is 1200 × 1.03 = 1236, so the overpriced forward creates a profit of 1300 − 1236 = 64 per ounce. The strategy earns that spread after repaying the loan.
The payoff is never negative because the holder can choose not to exercise
Explication
A put buyer has the right, not the obligation, to sell at the strike, so the holder can avoid a loss by not exercising. That makes the payoff nonnegative before premium is considered.
K minus c
Explication
For a short put, break-even occurs when the premium received exactly offsets the option’s eventual obligation, which is at K − c. This is the stock price where profit is zero at expiration.
A hedger
Explication
A hedger uses derivatives to offset losses from an existing exposure and reduce overall risk. A speculator mainly seeks profit from price movements.
Because the buyer pays a premium at trade time
Explication
Options are not free; the buyer pays a premium up front, so the contract has value at initiation. The seller receives that premium in exchange for taking on the obligation.
A clearinghouse settles gains and losses daily through mark-to-market
Explication
Daily settlement through a clearinghouse means gains and losses are realized continuously, which greatly limits credit exposure. This is a key difference from most OTC forwards.
When both parties open new positions
Explication
Open interest rises only when a new long and a new short are created together. It falls when both sides close positions, and it is not the same as trading volume.
When the margin account balance falls below the maintenance margin
Explication
A margin call occurs when the margin account drops below the maintenance margin, requiring the trader to add funds. The account is then typically restored to the initial margin level.
The daily revaluation of the position using the settlement price and updating the margin account
Explication
Daily mark-to-market means the contract is revalued each day at the settlement price, and gains or losses are posted to the margin account. It is not deferred until expiration like a forward.
Because the final basis at close-out is uncertain
Explication
Basis risk comes from uncertainty in the final basis, which affects the realized hedge outcome. Even with a futures hedge, changes in basis can make the effective price differ from the initial futures price.
It improves the outcome for a short hedge and worsens the outcome for a long hedge
Explication
When basis strengthens, the realized hedge result is better for a short hedge and worse for a long hedge. This reflects how changes in basis alter the effective price paid or received.
Using a futures contract on a different underlying asset than the one being hedged
Explication
Cross hedging uses a futures contract on a related but different underlying asset, such as hedging jet fuel with crude oil futures. This is done when an exact futures match is unavailable.
As correlation times the ratio of spot volatility to futures volatility
Explication
The minimum variance hedge ratio is computed as h* = ρ × (σS/σF). It uses correlation and relative volatility to choose hedge strength.
To remove systematic market risk from the portfolio
Explication
Setting target beta to zero aims to neutralize exposure to broad market movements, leaving mostly stock-specific return. It does not eliminate idiosyncratic risk.
26 contracts
Explication
The hedge uses N* = (β − β*) × (P/F) = 1.3 × (1,500,000/75,000) = 26. Shorting these contracts helps neutralize market exposure.
max(S - K, 0)
Explication
A call’s intrinsic value is the immediate exercise value, which is max(S − K, 0). This value is never negative.
A European option can be exercised only at expiration, while an American option can be exercised any time up to expiration
Explication
European options are exercisable only at expiration, whereas American options can be exercised at any time through expiration. The extra flexibility of American-style exercise is the defining difference.
Buying a put on stock you already own to limit downside risk
Explication
A protective put combines stock ownership with a long put, giving the investor the right to sell at the strike price and limit losses. A stop-loss reduces risk differently because it does not provide an option-like floor.
max(K - S_T, 0) - p
Explication
A long put pays off when the stock ends below the strike, so its payoff is max(K - S_T, 0), and the premium is then subtracted to get profit. The premium shifts the breakeven to K - p.
Mémorisez les réponses avec 22 flashcards sur Introduction to Derivatives and Hedging.
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.
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