CISI Derivatives (CISI) flashcards
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- Derivative
- A financial contract whose value depends on an underlying asset, rate, index or event, rather than on the instrument itself. Main families are futures, forwards, options and swaps.
- Central counterparty
- An entity that interposes itself between trade counterparties, becoming buyer to every seller and seller to every buyer, and manages default risk through margin and a default fund.
- Initial margin
- Collateral collected at the start of a cleared or non-cleared derivative position to cover potential future exposure over the close-out period, in addition to daily variation margin.
- Variation margin
- Payment made to settle the daily mark-to-market change in the value of a derivative position, preventing the build-up of large uncollateralised exposures.
- Close-out netting
- A contractual and legal mechanism that converts all outstanding obligations between two parties into a single net termination amount when one party defaults.
- Hedger
- A market participant who uses derivatives to reduce or offset an existing exposure, such as a farmer selling futures to fix the price of a future harvest.
- Arbitrageur
- A participant who exploits price discrepancies between related instruments, for example between a futures price and its underlying spot plus cost of carry, thereby enforcing pricing relationships.
- Over-the-counter market
- A decentralised market where participants negotiate customised derivative contracts bilaterally, without an exchange, and bear counterparty credit risk unless the trade is cleared.
- Forward contract
- A customised OTC agreement to buy or sell an asset at a fixed price on a future date, with no upfront payment and settlement only at maturity.
- Contango
- A market condition where the futures price exceeds the expected spot price, usually because storage, insurance and financing costs exceed the convenience yield of holding the physical asset.
- Backwardation
- A market condition where the futures price is below the expected spot price, typically because the convenience yield of holding the physical commodity exceeds its cost of carry.
- Basis
- The difference between the spot price of an asset and its futures price. Basis converges to zero as the futures contract approaches expiry.
- Minimum-variance hedge ratio
- The ratio of futures to spot exposure that minimises the variance of a hedged position, equal to the correlation times the ratio of spot to futures price volatility.
- Mark to market
- The daily revaluation of a futures position against the settlement price, with gains credited and losses debited to the margin account via variation margin.
- Maintenance margin
- The minimum margin balance that must be maintained on a futures position; a fall below this level triggers a margin call to restore the initial margin.
- Cash-and-carry arbitrage
- A strategy of buying the underlying asset, financing it and selling a futures contract when the futures price exceeds spot plus carry, locking in a riskless profit at expiry.
- Forward rate agreement
- An OTC contract that fixes an interest rate for a specified future period on a notional principal, settled in cash at the start of that period.
- Call option
- A contract giving the buyer the right, but not the obligation, to buy the underlying at a fixed strike price on or before expiry, in return for a premium.
- Put option
- A contract giving the buyer the right, but not the obligation, to sell the underlying at a fixed strike price on or before expiry, in return for a premium.
- Intrinsic value
- The amount by which an option is in the money: the maximum of spot minus strike for a call, and strike minus spot for a put, floored at zero.
- Time value
- The part of an option premium exceeding intrinsic value, reflecting the probability that the option becomes more valuable before expiry; it decays as expiry approaches.
- Put-call parity
- The no-arbitrage relationship for European options: call minus put equals spot minus the present value of the strike, adjusted for dividends. Violations permit arbitrage.
- Implied volatility
- The volatility input that, when entered into an option pricing model, reproduces the option's observed market price; it reflects the market's expectation of future price movement.
- Delta
- An option Greek measuring the change in the option premium for a small change in the underlying price; call deltas range from zero to one and put deltas from minus one to zero.
- Gamma
- An option Greek measuring the rate of change of delta as the underlying price changes; it is highest for at-the-money options close to expiry.
- Vega
- An option Greek measuring the sensitivity of the option premium to a change in implied volatility, in absolute terms or per one percentage point change.
- Covered call
- A strategy of holding the underlying asset and writing a call on it, generating premium income but capping upside gains above the strike price.
- Interest rate swap
- An agreement to exchange fixed and floating interest payments on a notional principal for a set period, used to hedge or take exposure to interest rate movements.
- Payer swap
- An interest rate swap in which the holder pays a fixed rate and receives a floating rate, so the position gains value when market interest rates rise.
- Credit default swap
- A contract in which the protection buyer pays a periodic spread to the seller, who compensates the buyer if a defined credit event occurs on the reference entity.
- Value at Risk
- A statistical estimate of the maximum loss on a portfolio over a specified horizon at a given confidence level, such as 99% one-day VaR.
- Expected shortfall
- The average loss conditional on the loss exceeding the Value at Risk threshold; a coherent risk measure that captures tail risk better than VaR alone.