Review of principles- derivatives( Part 2)

Section:__2FM5_ Course: FM 567 Name :__de Leon, Kamylle Anne t.___

Explain briefly the following questions:

Briefly define the following? (Using your own words) (30r)

1. Spot Price
A spot price is the current market price of a financial instrument which is either purchased
or sold immediately upon payment and delivery. It is the price where sellers and buyers
value an asset at the given moment.

2. Expiry
An Expiry is a date at which a contract, particularly a derivative contract, ends. On the
expiry date, the buyer and seller will settle the derivative contract.

3. Mark to Market
A Mark to Market is a term used to describe for the daily settling of gains and losses which
is the result of the changes in market value of a security. It is often used for financial
derivative instruments, such as futures contracts.

4. European Options
A European Option is a version of an options contract that prohibits any execution until its
expiry date. It is when an investor cannot call or put action of the underlying security,
unless it is on the date of option maturity.

5. Interest Rate Swap

An Interest Rate Swap is a type of derivative contract where the buyer and seller agree to
exchange or swap one stream of future interest payments that is based on a specified
principal amount.

6. Delivery
A Delivery is the final part of a contract in buying or selling of an instrument. It is where
1 financial instruments are being transferred and is given to and received by the buyer.

2 Provide a Sample Problem on the following topics with Solutions:

 
A. Put-Call Parity Agreement (15r)
Formula: C + K = F + P, where C is call price, K is strike price, F is futures price, and P is put price.
This formula is used as F – C + P – K = 0. For example, the given is:
F = $100
C = $5
P = $10
K = $105
Solution: 100 – 5 + 10 – 105 = 0. The answer should always sum up to zero, when there is an
increase in futures price and call price for instance, the put price must go down and adjust to have
a sum of zero.

B. Forward Rate Agreement (15r)

Company ABC and Company XYZ enter an FRA where: FRA = 3.5%, (R) Reference rate = 4%, (NP)
Notional Principal = $5 million, (P) Period (No. of days in the contract) = 181 days, (Y) Year (based
on contract) = 360 days
The FRA is computed as: [(R- FRA) x NP x P) / Y] X [ 1 / 1 + R X (P/Y)]
= [(4%-3.5%) x $5M x 181) / 360 days] X [ 1 / (1 + 4% X (181/360)]

= (12,569.44) X (0.980285)
= $12,321.64

Criteria for Scoring: (10 points for each) Grade: base 40 + 60/60 = 100% Activity
Substance Coherence
Clarity Sentence Construction
Accuracy
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