Financial Markets and Instruments
Instrument map
Equities (common, preferred, ADRs, ETFs), fixed income (government, corporate, money market, repo, floating rate notes), FX (spot, forwards, swaps), derivatives (futures, forwards, options, swaps) and commodities. Know contract specifications: notional, tick size, multiplier, delivery, margin and settlement conventions, and how primary and secondary market structure affects liquidity.
Pricing relationships
Bond prices and yields move inversely; use modified duration for small yield changes and add convexity for larger ones. DV01 is the cash change for a one-basis-point move. Forward rates follow from the spot curve under no-arbitrage; covered interest parity links spot, forward and the rate differential; put-call parity links options and the underlying. Futures and forwards differ through margining, credit exposure and convexity.
Traps
- Clean versus dirty price: the quoted price excludes accrued interest, the invoice price includes it.
- Mixing percentage price change with cash (DV01) effects.
- Forgetting that ETFs can trade at a premium or discount to NAV.
- Applying parity formulas without checking borrowing, short-sale and funding assumptions.
- Confusing yield to maturity with current yield or with realised holding-period return.
Worked example
A bond with modified duration 6.5 and convexity 80 faces a 50 bp yield rise. Approximate price change is -6.5 x 0.005 + 0.5 x 80 x 0.005^2 = -0.0325 + 0.001 = -3.15%. Duration alone overstates the loss because convexity is positive.