Term
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Definition
| It's when a short seller is forced to close his position if the broke runs out of securities to borrow - he will need to close his short position immediately |
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Term
| What two rules apply to short selling? |
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Definition
1 - the short seller must pay all dividendes due to the lender of the security
2 - The short seller must deposit collateral to guarantee the eventual repurchase of the security |
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Term
| In what ways are forward contracts and futures contracts similar? |
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Definition
- can be either deliverable or cash settlement contracts
- are priced to have zero value at the time the investor enters into the contract |
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Term
| How do forward contracts differ from futures contracts? |
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Definition
- Futures trade on exchanges, forwards are private contracts
- Futures are standardized, forwards are customised
- Single clearing house is the part to all futures contracts. Forwards are contracts with the originating counterparty
- Futures are regulated by government. Forwards are not regualted.
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Term
| What assumptions are made with the forward pricing model? |
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Definition
- No transaction costs
- Same tax rates
- Borrowing and lending at risk free rate
- Arbitrage opportunities exploited as they arise |
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Term
| Define the forward pricing model formula: |
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Definition
F0 = S0ert
Forward price (t0) = underlying asset price (t0) times econtinuously compounded risk free asset rate * time to maturity (in years) of the forward contract |
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Term
| What happens if F0 > S0ert ? |
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Definition
| Then arbitrageurs will profit by selling the forward and buying the asset with borrowed funds, forcing the sign to become = |
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Term
| Formula for computing forward price when the underlying pays a known amount of cash over it's lifetime? |
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Definition
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Term
| Formula for forward price when there are dividends? |
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Definition
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Term
| What is the initial value of a forward contract? |
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Definition
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Term
| Formula for value of the long contract on an asset with no cash flows? |
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Definition
S0 - Kert
K = obligated delivery price after inception |
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Term
| Formula for the value of a long forward contract on an asset with cash flows (of present value I) |
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Definition
S0 - I - Kert
Remember to discount the future values to present values
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Term
| Formula for the value of a long foward contract on an asset with a continuous dividend yield of q |
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Definition
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Term
What does IRP state?
State the IRP relationship formula? |
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Definition
Interest rate parity states that the forward exchange rate, F (measured in domestic unit of foreign currency), must be related to the spot exchange rate, S, and to the interest rate differential between the domestic and the foreign country, r - rf
F0 = S0.e(r-rf).T |
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Term
| Main difference between forward contracts and futures contracts? |
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Definition
daily marking to market requirements for futures
Forward and future prices are the same if interest rates are known over the life of a contract |
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Term
| Formula for forward contract price (F0) if there are storage costs of the underlying expressed as a known cash flow? |
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Definition
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Term
| Formula for forward contract price (F0) if there are storage costs expressed as a yield (percentage)? |
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Definition
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Term
| What is the convenience yield? |
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Definition
| measure of the benefit of owning spot, or physical, consumption commodities |
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Term
What is backwardation?
When does it occur? |
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Definition
- situation where futures price is below the spot price
- For this to occur this must be a significnat benefit to holding the asset |
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Term
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Definition
| situation where the futures price is above the spot price. If there are no benefits to holding the asset (eg, dividends, coupons or convenience yield), contango will occur because the futures price will be greater than the spot price. |
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