CIRO Derivatives Exam flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Derivative contract

A financial contract whose value depends on an underlying asset, rate, index or event, with no requirement that principal be exchanged at inception.

Basis

The difference between the spot price and the futures price of the same underlying; it converges to zero as the futures contract approaches expiry.

Cost of carry model

Prices futures as spot compounded at the financing rate plus storage costs minus convenience yield over the time to expiry, adjusted for dividends where relevant.

Put-call parity

For European options on a non-dividend asset, call minus put equals spot minus the present value of the strike; violations allow arbitrage.

Option delta

The change in an option's premium for a one-unit change in the underlying price; it also approximates the hedge ratio.

Implied volatility

The volatility input that makes a pricing model reproduce the observed market premium; it reflects market expectations and supply-demand imbalance.

Minimum-variance hedge ratio

Covariance between spot and futures returns divided by futures variance; the position size that minimises the variance of the hedged exposure.

Value at Risk

A loss threshold that will not be exceeded with a stated probability over a stated horizon, under normal market conditions.

Central counterparty

An entity that interposes itself between trade counterparties, becoming buyer to every seller and seller to every buyer to mutualise default risk.

Novation

The legal replacement of a bilateral contract with two contracts, one between each original party and the central counterparty.

Default waterfall

The contractual order in which losses from a defaulted clearing member are absorbed, from that member's margin to mutualised default fund resources.

Initial margin

Collateral collected to cover potential future exposure from a counterparty default over the assumed close-out period.

Variation margin

Collateral exchanged to settle the current mark-to-market exposure arising from price moves since the previous margin call.

Wrong-way risk

The risk that exposure to a counterparty increases at the same time as the counterparty's probability of default rises.

Clearing obligation

A regulatory requirement that specified classes of standardised derivatives be cleared through an authorised central counterparty.

Trade repository reporting

Submission of trade details, counterparties, valuation and collateral to a registered repository so regulators can monitor systemic risk.

Position limits

Caps set by regulators or exchanges on the size of speculative positions a person may hold in a contract or commodity.

Suitability assessment

An evaluation of a client's knowledge, experience, financial situation and objectives to determine whether a product or service is appropriate.

Target market

The defined group of clients for whom a product is designed, described by characteristics, objectives and risk tolerance.

Risk warning

A disclosure stating that leveraged derivatives can lose more than the amount invested and that margin calls may be made at short notice.

Contango

A market condition in which futures prices exceed the spot price, typically because carry costs exceed convenience yield.

Convenience yield

The non-monetary benefit of holding the physical commodity rather than a futures position, which lowers the futures price relative to carry.

Open interest

The number of derivative contracts outstanding and not yet closed or delivered, used as a measure of participation and liquidity.

First notice day

The first day on which a holder of a long futures position may be assigned delivery under the contract terms.

Gamma

The rate of change of an option's delta with respect to the underlying price; high gamma means frequent hedge rebalancing.

Theta

The sensitivity of an option's premium to the passage of time, usually negative for long option positions as expiry approaches.

Volatility smile

The pattern in which implied volatility differs across strikes, often higher for out-of-the-money options than at-the-money options.

Expected shortfall

The average loss in the worst tail of the distribution beyond the Value at Risk threshold, making it a coherent risk measure.

Beta hedging

Sizing an index futures short as portfolio beta multiplied by portfolio value divided by futures notional, to remove market exposure.

Trade affirmation

Confirmation of a trade's economic terms between counterparties before the clearing deadline, enabling submission to the central counterparty.

Collateral haircut

A percentage reduction in the value of posted collateral to cover price volatility and liquidation costs if the counterparty defaults.

Close-out netting

A contractual and legal process that offsets all transactions with a defaulted counterparty into a single net amount owed.