Derivative Products
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What is a derivative product in the context of treasury management?
A derivative is a financial instrument whose value is derived from an underlying asset such as interest rates, currencies, equities, or commodities. It is used for hedging risk or speculation without necessarily holding the underlying asset.
What is 'theta' in options pricing and what does it measure?
Theta measures the rate of time decay in an option's value.
What are the four main types of derivative instruments used in bank treasury operations?
The four main types are forwards, futures, options, and swaps. Each serves distinct purposes in managing interest rate, currency, credit, and commodity risk.
What is 'rho' in option sensitivity measures?
Rho measures an option's sensitivity to changes in interest rates.
What is a forward rate agreement (FRA) and how is it used by banks?
An FRA is an OTC contract that fixes an interest rate for a future borrowing or lending period, settled in cash at maturity based on the difference between the contracted rate and the reference rate (usually MIBOR/LIBOR). Banks use FRAs to hedge short-term interest rate risk.
What is an 'in-the-money' option?
An option whose exercise would produce a positive cash flow.
How does an interest rate swap (IRS) work in a bank's treasury portfolio?
In an IRS, two parties exchange cash flows — typically one pays a fixed rate while the other pays a floating rate — on a notional principal amount without exchanging the principal itself. Banks use IRS to convert fixed-rate assets or liabilities into floating ones and vice versa.
What is an 'out-of-the-money' option?
An option whose exercise would result in a net loss.
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