Financial Analysis & Derivatives Flashcards
6 cards from real IMC practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 6 Financial Analysis & Derivatives flashcards as text
What does 'intrinsic value' mean for an option?
Answer: The amount by which an option is 'in the money' — the difference between the current asset price and the strike price
Intrinsic value is the immediate exercise value of an option: for a call, it is max(0, Asset Price - Strike Price); for a put, it is max(0, Strike Price - Asset Price). An option with positive intrinsic value is 'in the money'. Total option value = intrinsic value + time value.
What is 'implied volatility' in options pricing?
Answer: The market's expectation of future volatility implied by the current market price of an option
Implied volatility is extracted from current option market prices using an options pricing model (like Black-Scholes). It represents the market's consensus expectation of how volatile the underlying asset will be over the option's lifetime. High implied volatility means more expensive options.
What is an 'interest rate swap' and its most common use?
Answer: An agreement where two parties exchange fixed and floating interest rate payments on a notional principal, most commonly used to manage interest rate exposure
In a plain vanilla interest rate swap, one party pays a fixed rate while receiving a floating rate (e.g., SONIA) from the other party, on an agreed notional amount. They are used to convert fixed-rate borrowing to floating or vice versa, managing interest rate risk.
What is the 'delta' of an option?
Answer: The rate of change of an option's price relative to a £1 change in the price of the underlying asset
Delta measures an option's sensitivity to changes in the underlying asset's price. A delta of 0.5 means the option price changes by £0.50 for every £1 move in the underlying. Delta ranges from 0 to 1 for calls and -1 to 0 for puts.
What is 'hedging' in investment management?
Answer: Taking an offsetting position in a related instrument to reduce or eliminate the risk of adverse price movements in an existing position
Hedging involves taking a position in a derivative or related asset that offsets (reduces) an existing risk. For example, buying put options to protect a long equity portfolio against a market fall. Perfect hedging eliminates risk but also eliminates upside.
What is 'gamma' in options risk management?
Answer: The change in delta resulting from a £1 change in the underlying asset price
Gamma measures the rate of change of an option's delta for a £1 change in the underlying asset. High gamma means delta changes rapidly, making the option's price behaviour more unpredictable. Gamma is highest for at-the-money options close to expiry.