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Unformatted text preview: EC3070 FINANCIAL DERIVATIVES GLOSSARY Ask price The bid price. Arbitrage An arbitrage is a financial strategy yielding a riskless profit and requiring no investment. It commonly amounts to the successive purchase and sale, or vice versa, of an asset at differing prices in different markets. i.e. it involves buying cheap and selling dear or selling dear and buying cheap. Bid A bid is a proposal to buy. A typical convention for vocalising a bid is p for n : p being the proposed unit price and n being the number of units or contracts demanded. Backwardation Backwardation describes a situation where the amount of money required for the future delivery of an item is lower than the amount required for immediate delivery. Backwardation is a signal that the item in question is in short supply. The opposite market condition to backwardation is known as contango, which is when the spot price is lower than the futures price. In fact, there is some ambiguity in the usage of the term. According to the definition above, backwardation is when F | < S , where F | is the current price for a delivery at time and S is the current spot price. In an alternative definition, backwardation exists when F | < E ( F | t ) with 0 < t < , which is when the expected future price at a later date exceeds the futures price settled at time t = 0. In modern usage, this is called normal backwardation. Buyer A buyer is a long position holder who has agreed to accept the delivery of a commodity at some future date. Capital Asset Pricing Model (CAPM) The capital asset pricing model describes the relationship between the expected return of an asset, or a portfolio of assets, and the return of the stock market as a whole. The relationship is expressed via the formula E ( r i ) r f = { E ( r m ) r f } , where E ( r i ) is the expected return on the capital asset or portfolio, E ( r m ) is the expected return of the market, r f is the risk-free rate of interest, such as the interest from government bonds, and is the coecient of the sensitivity of the asset returns to market returns. Here, = C ( r i , r m ) /V ( r m ), which is known as the beta, is just the coecient of the regression of r i on r m . The difference E ( r m ) r f is sometimes known as the market premium or risk premium. Contango Contango is the situation where the price of a commodity for future delivery is higher than the spot price, or a far future delivery price is higher than a nearer future delivery price. The opposite market condition to contango is known as backwardation....
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This note was uploaded on 03/02/2012 for the course EC 3070 taught by Professor D.s.g.pollock during the Spring '12 term at Queen Mary, University of London.

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