MMP321 Lecture Notes - Lecture 9: Futures Contract, Interest Rate Cap And Floor, Financial Instrument

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31 May 2021
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MMP321 Topic 9 Seminar Solutions
1
Topic 9: Property Derivatives
Question 1:
What is a derivative product?
ANSWER:
A derivative is a financial security that derives its value from an underlying asset.
Question 2:
How does a derivative product get its value?
ANSWER:
A derivative products value is determined by the value of the underlying asset. For
example, if the underlying asset increases in the value the value of a derivative that
gives the holder the right to buy will also increase. Therefore the returns from
derivative are based on the returns of the underlying asset.
Question 3:
What right does the holder of a derivative product have?
ANSWER:
The holder of a derivative has the right to buy or sell the underlying asset at a
certain point in the future at a price that is agreed upon today. The holder of a
derivative does not own the underlying asset.
Question 4:
Describe the features of a futures contract.
ANSWER:
A futures contact is a standardized contract traded on a formal exchange that gives
the holder the right (and the obligation) to buy or sell the underlying asset at some
point in the future at a price that is set today. The purchaser of the futures contract
is required to deposit a margin with the exchange to protect against losses that may
be incurred from the contract (reducing risk of default). Most futures contracts are
settled by payment in cash of the profit or loss from the contract. Or by taking a
reversing trade before maturity.
Question 5:
Identify and describe a two derivative products that can be used to manage interest
rate risk.
ANSWER:
Derivatives that can be used to manage interest rate risk include:
Interest Rate Futures
Interest Rate Swaps
Interest Rate Options
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