Derivatives & Hedging Strategies Flashcards

A total return swap allows the protection buyer to:

Answer: Transfer the credit and market risk of a reference asset to the counterparty

In a total return swap, the buyer pays the total return of a reference asset and receives a floating rate, effectively transferring both credit and market risk.

The delta of a deep in-the-money call option approaches:

Answer: 1

As a call option moves deep in-the-money, it behaves increasingly like the underlying asset itself, so delta approaches 1.

Which strategy profits from low volatility and a range-bound underlying asset?

Answer: Long iron condor

A long iron condor involves selling an OTM strangle and buying a wider OTM strangle, profiting when the underlying stays within a defined range.

For a bond portfolio manager, duration-based hedging using Treasury futures requires adjusting the number of contracts based on:

Answer: The dollar duration of the portfolio and the futures contract

The number of futures contracts needed equals the target dollar duration change divided by the dollar duration of one futures contract.

A swaption that gives the holder the right to enter a swap as the fixed-rate payer is called a:

Answer: Payer swaption

A payer swaption grants the right to pay fixed and receive floating, and gains value when interest rates rise.

The cost-of-carry model for futures pricing includes all of the following EXCEPT:

Answer: Credit spread of the futures seller

The cost-of-carry model incorporates risk-free rate, storage costs, and convenience yield; exchange-cleared futures eliminate counterparty credit spread.

Which derivative instrument is most appropriate for hedging the risk that a planned future investment will be made at a higher interest rate than current rates?

Answer: A receiver swaption

A receiver swaption gives the right to receive fixed rates; if rates fall before the investment, it compensates by locking in the higher fixed rate.