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dexazuxo's version from 2017-05-13 09:22


Question Answer
Why do we need or use derivatives?Risk management: These are tools for companies and other users to manage risk.
Hedging: Alter exposure to an asset/risk you already have
Investment/speculation: Take on the exposure to an asset/risk AND speculate against or in favour of that asset
Why we need it?: Makes risk transfers and speculation cheaper. Makes it easier to acquire rights to an asset while reducing costs. Transactions are lumped together therefore reduced number of transactions = reduced transaction costs. provides ways to make highly leveraged bets.
What are the 2 principles underlying the arbitrage pricing method?The law of one price: Two things that are equivalent cannot sell for different prices. If it does, then unlimited risk free profits are possible
The law of no arbitrage: A portfolio with zero risk, and zero net investment, and positive expected returns cannot exist. If it does its called an arbitrage opportunity. This would be eliminated by market forces.
KEY: the absence of arbitrage implies that 2 have the same price.
What are the different types of derivatives? Forward/futures, Swaps, Call option, Put option
What are forward/futures? Forward contract: is an agreement toby/sell an asset by a certain time for a certain price. The contract pre specifies:
- Quantity and type of asset
- Delivery date and place
- Forward price
By entering into this contract, both buyer and seller are obligated to carry out this transaction. Entering into a forward contract is free and traded over the counter.
Forward contracts: These are standardised forward contracts that are exchange traded and regulated.
Who uses derivatives? End user: Corporations, investment managers, and investors use these to manage risk, speculate are lower transaction costs or avoid a rule.
Market maker: sell to customers who want to buy, and buy from customers who want to sell. They spread a charge. Concerned about price, and hedging derivatives.
Economic observer and regulator: Observe and try to understand the derivatives market, then come up with regulations to minimise risk.
Financial engineer: They are the intellectual drivers of the derivatives market. They invent multiple exchange swaps between participants in complicated markets.
How accountants do aggressive accounting.1. Recording revenues too soon
2. Recording investment income as revenue
3. Capitalising normal expenses
4. Understate COGS
5. Underestimate bad debts
What is cash flow from financing? Money that is exchanged between firms and external financial providers e.g.. banks, bond holders