Monday, November 7, 2011

Derivatives for stock market and share price CFA FRM

CFA FRM Derivatives for stock market and share price

Future and Forwards are the most important instruments that you will come across. The areas that I find very interesting are valuation methodologies. In particular to CFA Level 1 the interesting things are forward rate agreement and interest swaps and their pricing/valuations.

Forward Rate Agreement:
Payment to long the settlement = Notional Principle {[floating rate settlement - forward rate] * [days/360]}/[1+floating rate*(days/360)]
Here, the denominator is the present-vale of difference occurring in the future.

Put call parity:
C+ X/{(1+RFR)^T} = S+P
Left side is the call wit ha risk free bond giving X at expiry, and right side is protective put(composed of share and long put, meaning we are buying stock and put).
Carefully observing that both are having same effect what so ever happens.

Table of process of marking to market of future contract is an important area.
There are 2 cases: Taking long vs taking short on futures. After that there are 2 margins: Initial margin & maintained. Profit or loss realized are not allowed to incur. In most of the cases the price changes daily and therefore we have loss profit for the future locked trade. This technique is very important as it makes sure that no one ever defaults by calling money at margins, still allowing us to play at margin.

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