Financial products and instruments
Financial products and instruments tests how cash flows, payoff profiles, and risk exposures differ across cash, fixed income, equity, FX, and derivatives, and how those differences drive pricing and suitability. Expect calculation items plus instrument-selection questions.
Build the instrument map
- Cash instruments include deposits, commercial paper, and bonds; derivatives include forwards, futures, options, and swaps.
- For each instrument identify the obligation, counterparty risk, collateral, and whether the payoff is linear or nonlinear.
- A bond combines coupon, principal, yield, duration, and credit spread. Equity is a residual claim. An FX forward locks an exchange rate; an option pays a premium for a right, not an obligation.
Pricing and risk drivers
Price is the present value of expected cash flows discounted at the relevant curve plus spread. Higher yields lower fixed-rate bond prices. Option value depends on underlying price, strike, volatility, time, rates, and dividends. Futures and forwards differ through margining, collateral, and counterparty structure.
Worked example
A 2-year 5% annual-coupon bond with face value 100 is priced at a 4% yield. Price = 5/1.04 + 105/1.04^2 = 4.81 + 97.08 = 101.89. If the yield rises to 5%, price = 5/1.05 + 105/1.05^2 = 100.00. The fixed coupon did not change; the discount rate did, so the present value fell.
Traps
Confusing coupon with yield; omitting accrued interest; treating an option premium as the strike; assuming futures equal forwards when collateral and rates matter; ignoring counterparty risk in OTC derivatives.