CFA Level I Derivatives and Risk Management

How do futures differ from forwards?

The clearing house reduces counterparty risk.

A call has a strike of $50. At expiry the share is $60. What is the payoff?

max(0, S − K).

You buy a put with a $50 strike for $3. At expiry the share is $40. What is your profit?

Payoff 10 minus the premium 3.

Put-call parity states:

A fiduciary call equals a protective put.

A share is $50, the present value of the $50 strike is $48 and a European call costs $5. What should the put cost?

p = c + PV(K) − S = 5 + 48 − 50.

A share is $100, pays no income, and the risk-free rate is 5%. What is the no-arbitrage 1-year forward price?

F = S × (1 + r).

An interest rate swap can be seen as:

Each settlement is like a forward rate agreement.

What is the most a put buyer can lose?

A put seller can lose up to the strike minus the premium.

A call is in the money when:

A put is in the money when the price is below the strike.

Higher volatility of the underlying usually makes options:

More volatility means more chance of a big payoff, with losses capped.

Owning a share and buying a put on it is called:

It sets a floor on losses.

What does a covered call do?

Long share plus short call.

In a one-period binomial model, up = 1.2, down = 0.8 and the risk-free rate is 5%. What is the risk-neutral probability of an up move?

(1.05 − 0.8) / (1.2 − 0.8).

A portfolio's 1-day 5% VaR is $1 million. What does it mean?

VaR says nothing about how big losses are beyond that level.

What does the buyer of credit default swap protection do?

It works like insurance against default.

Two assets with identical cash flows trade at different prices. What does no-arbitrage pricing say?

Arbitrageurs buy the cheap one and sell the dear one.

Which is a non-financial risk?

Others include legal, compliance, model and tax risk.