Derivatives
　　Derivatives-financial instruments that derive their value from the value of some underlying asset-have become increasingly important and fundamental in effectively managing financial risk and creating synthetic exposures to asset classes. As in other security markets, arbitrage and market efficiency play a critical role in establishing prices.
　　This study session builds the conceptual framework for understanding the basic derivatives (forwards, futures, options, and swaps), derivative markets, and the use of options in risk management.
　　READING ASSIGNMENTS
　　Reading 57 Derivative Markets and Instruments Analysis of Derivatives for the Chartered Financial Analyst Program, by Don M. Chance, CFA
　　Reading 58 Forward Markets and Contracts Analysis of Derivatives for the Chartered Financial Analyst Program, by Don M. Chance, CFA
　　Reading 59 Futures Markets and Contracts Analysis of Derivatives for the Chartered Financial Analyst Program, by Don M. Chance, CFA
　　Reading 60 Option Markets and Contracts Analysis of Derivatives for the Chartered Financial Analyst Program,by Don M. Chance, CFA
　　Reading 61 Swap Markets and Contracts Analysis of Derivatives for the Chartered Financial Analyst Program, by Don M. Chance, CFA
　　Reading 62 Risk Management Applications of Option Strategies Analysis of Derivatives for the Chartered Financial Analyst Program,by Don M. Chance, CFA
　　LEARNING OUTCOMES
　　READING 57. DERIVATIVE MARKETS AND INSTRUMENTS
　　The candidate should be able to:
　　a define a derivative, and distinguish between exchange-traded and over-the-counter derivatives;
　　b contrast forward commitments with contingent claims;
　　c define forward contracts, futures contracts, options (calls and puts), swaps, and credit derivatives, and compare their basic characteristics;
　　d describe purposes of, and controversies related to, derivative markets;
　　e explain arbitrage and the role it plays in determining prices and promoting mar?ket efficiency.
　　READING 58. FORWARD MARKETS AND CONTRACTS
　　The candidate should be able to:
　　a explain delivery/settlement and default risk for both long and short positions in a forward contract;
　　b describe the procedures for settling a forward contract at expiration, and how termination prior to expiration can affect credit risk;
　　c distinguish between a dealer and an end user of a forward contract;
　　d describe characteristics of equity forward contracts and forward contracts on zero-coupon and coupon bonds;
　　e describe characteristics of the Eurodollar time deposit market, and define LIBOR and Euribor;
　　f describe forward rate agreements (FRAs) and calculate the gain/loss on a FRA;
　　g calculate and interpret the payoff of a FRA and explain each of the component terms of the payoff formula;
　　h describe characteristics of currency forward contracts.
　　READING 59. FUTURES MARKETS AND CONTRACTS
　　The candidate should be able to:
　　a describe the characteristics of futures contracts;
　　b compare futures contracts and forward contracts;
　　c distinguish between margin in the securities markets and margin in the futures markets, and explain the role of initial margin, maintenance margin, variation margin, and settlement in futures trading;
　　d describe price limits and the process of marking to market, and calculate and interpret the margin balance, given the previous day’s balance and the change in the futures price;
　　e describe how a futures contract can be terminated at or prior to expiration;
　　f describe characteristics of the following types of futures contracts: Treasury bill, Eurodollar, Treasury bond, stock index, and currency.
　　READING 60. OPTION MARKETS AND CONTRACTS
　　The candidate should be able to:
　　a describe call and put options;
　　b distinguish between European and American options;
　　c define the concept of moneyness of an option;
　　d compare exchange-traded options and over-the-counter options;
　　e identify the types of options in terms of the underlying instruments;
　　f compare interest rate options with forward rate agreements (FRAs);
　　g define interest rate caps, floors, and collars;
　　h calculate and interpret option payoffs and explain how interest rate options differ from other types of options;
　　i define intrinsic value and time value, and explain their relationship;
　　j determine the minimum and maximum values of European options and American options;
　　k calculate and interpret the lowest prices of European and American calls and puts based on the rules for minimum values and lower bounds;
　　l explain how option prices are affected by the exercise price and the time to expiration;
　　m explain put-call parity for European options, and explain how put-call parity is related to arbitrage and the construction of synthetic options;
　　n explain how cash flows on the underlying asset affect put-call parity and the lower bounds of option prices;
　　o determine the directional effect of an interest rate change or volatility change on an option’s price.
　　READING 61. SWAP MARKETS AND CONTRACTS
　　The candidate should be able to:
　　a describe characteristics of swap contracts and explain how swaps are terminated;
　　b describe, calculate, and interpret the payments of currency swaps, plain vanilla interest rate swaps, and equity swaps.
　　READING 62. RISK MANAGEMENT APPLICATIONS OF OPTION STRATEGIES
　　The candidate should be able to:
　　a determine the value at expiration, the profit, maximum profit, maximum loss, breakeven underlying price at expiration, and payoff graph of the strategies of buying and selling calls and puts and determine the potential outcomes for investors using these strategies;
　　b determine the value at expiration, profit, maximum profit, maximum loss, breakeven underlying price at expiration, and payoff graph of a covered call strategy and a protective put strategy, and explain the risk management applica?tion of each strategy.
　　　
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