FINAL REVIEW

FINAL REVIEW - Finance 338 Final Review Exam I I....

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Finance 338 Final Review Exam I I. Components of Credit Risk - Current Credit Risk: address whether current obligations will be met - Potential Credit Risk: associated with a counterparty defaulting at a later date - Derivatives Credit Risk o Credit risk of forward contracts: Who bears credit risk if the market (spot) price of the underlying is greater than the forward price? The buyer (the person who was long) bears the credit risk the market (spot) price of the underlying is less than the forward price? The seller (the person who was short) bears the credit risk o Credit risk of options: Who bears credit risk? Whoever owns/buys the option The risk is if the buyer fails to pay The party with the positive gain bears the credit risk II. Special Purpose Vehicles - Subsidiaries set up by a parent company to engage in certain transactions. - Separate from the parent organization and not liable for the debt of the parent company. - Set up to have a high credit rating (e.g. high capitalization) o therefore engage in transactions that the parent cannot. - The parent is responsible for the debts of the SPV only up to the equity investment the parent made in the SPV. III. Derivatives Review Derivatives: cannot stand alone; value derived from value of other asset Over – The – Counter transactions: default risk; resembles a privately negotiated contract between two firms Exchange trade derivatives: no default risk; standardized contracts with the terms established by the exchange Long Call Payoff = max (spot price – x, 0) > 0 Long Call Profit = long call payoff – call premium Short Call Payoff = - max (spot price – x, 0) < 0 Short Call Profit = short call payoff - call premium Long Put Payoff = max (x – spot price, 0) > 0 Long Put Profit = long put payoff – put premium Short Put Payoff = - max (x – spot price, 0) < 0 Short Put Profit = short put payoff - put premium
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Forward Payoffs Short Forward Payoff = (spot price – forward price) X quantity Long Forward Payoff = (forward price – spot price) X quantity Forward or Future Contracts - a contract obligates the purchaser (seller) to: o buy (sell) a given asset o at a given price and quantity forward contracts have some pre-determined price called the forward price (called future price in future contracts) o on a given date - linear contracts - risk is two-sided - the short position’s loss/gain equals the long position’s loss/gain Long Position: the buyer agrees to take future delivery of the goods and is said to have taken a long position Short Position: the seller agrees to deliver the goods and is said to have taken a short position Forwards - private contracts - unique contracts - have default risk - require no up-front cash - have low or no regulation - not a standard price Futures - exchange – traded contracts - structured contracts - guaranteed by the exchange clearinghouse - require margin account deposits - are regulated - no default risk - locking in a contract now to be taken care of in the future
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This note was uploaded on 09/26/2011 for the course FINA 338 taught by Professor Harris during the Spring '11 term at UNL.

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FINAL REVIEW - Finance 338 Final Review Exam I I....

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