FM Derivatives and Options Flashcards

An interest rate swap in which Party A pays a fixed rate and receives a floating rate results in Party A having:

Answer: Fixed-to-floating exposure, benefiting if floating rates rise

Paying fixed and receiving floating means Party A benefits when floating rates rise above the fixed rate.

The swap rate in a plain vanilla interest rate swap is the fixed rate that makes the swap's initial value:

Answer: Equal to zero (fair swap)

The fixed swap rate is set so that the present value of fixed payments equals the present value of expected floating payments, making initial value zero.

A futures contract differs from a forward contract primarily because futures are:

Answer: Exchange-traded and marked to market daily

Futures are standardized, exchange-traded, and subject to daily mark-to-market settlement, which virtually eliminates counterparty risk.

The intrinsic value of a put option with strike K and current asset price S is:

Answer: max(K − S, 0)

Put intrinsic value is max(K − S, 0): positive when the asset is below the strike, zero otherwise.

On the FM exam, a 'cap' is a series of interest rate call options (caplets) used by borrowers to:

Answer: Limit the maximum interest rate paid on a floating-rate loan

An interest rate cap protects a floating-rate borrower from rising rates by providing payoffs whenever the reference rate exceeds the cap rate.

Under the FM exam syllabus, the payoff of a short forward position at maturity with forward price F₀ and spot price S_T is:

Answer: F₀ − S_T

The short forward holder delivers the asset and receives F₀, so payoff = F₀ − S_T.