FM Derivatives and Options Flashcards

A 'floor' is a series of interest rate put options (floorlets) used by investors to:

Answer: Guarantee a minimum interest rate received on a floating-rate investment

An interest rate floor protects a floating-rate investor from falling rates by providing payoffs when the reference rate drops below the floor rate.

A collar strategy involves:

Answer: Buying a put at a lower strike and selling a call at a higher strike to hedge an asset

A collar limits an asset's downside by buying a put and finances part of the cost by selling a call, capping upside.

Under the FM exam framework, if no arbitrage holds and dividends are paid at continuous rate q, the forward price is:

Answer: F₀ = S₀ × e^((r−q)T)

With continuous dividends at rate q, the cost-of-carry model gives F₀ = S₀ · e^((r−q)T).

The delta of a long call option is always:

Answer: Between 0 and 1

Call delta ∈ (0, 1): the option price rises by less than $1 for each $1 increase in the underlying asset.

A straddle is formed by:

Answer: Buying a call and a put with the same strike and expiration

A long straddle profits from large price moves in either direction by combining a long call and a long put at the same strike.

In the context of the FM exam, 'hedging' with derivatives means:

Answer: Reducing or eliminating price risk by taking an offsetting position

Hedging uses derivatives to offset existing price exposures, reducing financial risk rather than seeking profit.