CCM Derivatives flashcards

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

Notional principal

The reference amount on which derivative payments are calculated. It is usually not exchanged, but it determines the size of cash flows and the scale of exposure.

Futures versus forwards

Futures are exchange-traded, standardized, cleared, and marked to market daily. Forwards are customized bilateral OTC contracts settled at maturity, carrying counterparty credit exposure.

Put-call parity

For European options on a non-dividend asset, C minus P equals S minus the present value of the strike. Deviations permit arbitrage through replication.

Option delta

The change in an option's value for a one-unit change in the underlying price. Call deltas range from zero to one; put deltas range from minus one to zero.

Variation margin

A daily payment that settles mark-to-market gains and losses on a cleared or collateralized derivative position, keeping current exposure close to zero.

Modified duration

A measure of a bond's percentage price sensitivity to a small change in yield, computed as Macaulay duration divided by one plus the yield per period.

DV01

The dollar change in a position's value for a one basis point move in yields, equal to modified duration times dirty price times 0.0001.

Payer interest rate swap

A swap in which the holder pays a fixed rate and receives a floating rate. It increases in value when market interest rates rise.

Interest rate cap

A series of call options on a reference rate that pays the holder when the rate exceeds the strike, protecting a floating-rate borrower from rate increases.

Convexity adjustment

The second-order term in the price-yield relationship. It corrects duration-based estimates and makes long positions gain more when yields fall than they lose when yields rise.

Key rate duration

The sensitivity of a position's value to a change in a single point on the yield curve, capturing non-parallel curve shifts that aggregate duration ignores.

Transaction exposure

The risk that exchange rate movements change the domestic-currency value of firm foreign-currency receivables, payables, or committed transactions before settlement.

Translation exposure

The risk that exchange rate changes alter reported consolidated financial statements when foreign subsidiary accounts are converted into the parent's reporting currency.

Covered interest parity

A no-arbitrage relationship in which the forward exchange rate reflects the interest rate differential between two currencies, preventing riskless covered arbitrage.

FX zero-cost collar

A hedge combining a purchased currency option with a sold offsetting option whose premium funds the purchase, setting a band on the future exchange rate.

Economic FX exposure

The risk that exchange rate changes affect a firm's future competitiveness, cash flows, and market value, even without existing foreign-currency contracts.

Short hedge

A futures position that sells contracts to protect inventory or expected production against a decline in the commodity price before sale.

Long hedge

A futures position that buys contracts to protect a future purchase requirement against a rise in the commodity price before buying.

Contango

A market condition in which futures prices exceed the spot price, typically reflecting storage costs, financing costs, and convenience yield.

Backwardation

A market condition in which futures prices are below the spot price, often reflecting a high convenience yield or near-term supply shortage.

Basis risk in commodities

The risk that the price difference between the hedged local commodity and the benchmark futures contract changes, leaving part of the exposure unhedged.

Beta-adjusted hedge ratio

The notional of index futures needed to hedge an equity portfolio, computed as portfolio value times portfolio beta divided by the futures price.

Potential future exposure

A statistical estimate of the maximum mark-to-market exposure to a counterparty over a future horizon at a given confidence level, used for credit limits.

Credit value adjustment

The market value of counterparty default risk, equal to the expected loss from default, which reduces the fair value of a derivative asset.

Wrong-way risk

A condition in which exposure to a counterparty rises as the counterparty's credit quality deteriorates, increasing expected loss beyond standard assumptions.

Credit support annex

A document to the ISDA master agreement that sets collateral thresholds, eligible collateral, haircuts, and valuation and transfer mechanics between counterparties.

Netting set

A group of transactions with one counterparty governed by an enforceable netting agreement, so exposure is the net positive mark-to-market, not the sum of gross values.

Cash flow hedge

A hedge of a forecasted transaction or variable cash flows; the effective portion of derivative gains and losses is deferred in OCI until earnings are affected.

Fair value hedge

A hedge of an recognized asset, liability, or firm commitment's fair value; changes in both the hedging instrument and hedged item are recognized in earnings.

Fair value hierarchy

A three-level classification of valuation inputs: Level 1 quoted prices, Level 2 observable inputs, and Level 3 unobservable inputs, with disclosures required by level.

Hedge effectiveness

The degree to which changes in the hedging instrument offset changes in the hedged item's fair value or cash flows, assessed at inception and on an ongoing basis.

Segregation of duties

A control that separates trade execution, confirmation and settlement, and independent valuation and reporting among different personnel to reduce error and fraud risk.

Trade confirmation

A written record of a derivative's economic terms exchanged with the counterparty and matched before settlement, forming the legal evidence of the transaction.