CFA Refresher Readings
Derivative Instruments: Study Session 17
Learning Outcome Statements
“Option Markets and Contracts”
The practitioner should be able to:
- Calculate and interpret the prices of a synthetic call option, synthetic put option, synthetic bond, and synthetic underlying stock, and infer why an investor would want to create such instruments
- Calculate and interpret prices of interest rate options and options on assets using one- and two-period binomial models
- Explain the assumptions underlying the Black–Scholes–Merton model and their limitations
- Explain how an option price, as represented by the Black–Scholes–Merton model, is affected by each of the input values (the option Greeks)
- Explain the delta of an option, and demonstrate how it is used in dynamic hedging
- Explain the gamma effect on an option’s price and delta and how gamma can affect a delta hedge
- Discuss the effect of the underlying asset’s cash flows on the price of an option
- Demonstrate the methods for estimating the future volatility of the underlying asset (i.e., the historical volatility and the implied volatility methods)
- Illustrate how put–call parity for options on forwards (or futures) is established
- Compare and contrast American options on forwards and futures to European options on forwards and futures, and identify the appropriate pricing model for European options
The practitioner should be able to:
- Distinguish between the pricing and valuation of swaps
- Explain the equivalence of the following swaps to combinations of other instruments: interest rate swaps to a series of off market forward rate agreements (FRAs) and a plain vanilla swap to a combination of an interest rate call and interest rate put
- Calculate and interpret the fixed rate on a plain vanilla interest rate swap and the market value of the swap during its life
- Calculate and interpret the fixed rate, if applicable, and the foreign notional principal for a given domestic notional principal on a currency swap, and determine the market values of each of the different types of currency swaps during their lives
- Calculate and interpret the fixed rate, if applicable, on an equity swap and the market values of the different types of equity swaps during their lives
- Explain and interpret the characteristics and uses of swaptions, including the difference between payer and receiver swaptions
- Identify and calculate the possible payoffs and cash flows of an interest rate swaption
- Calculate and interpret the value of an interest rate swaption on the expiration day
- Evaluate swap credit risk for each party and over the life of the swap, distinguish between current credit risk and potential credit risk, and illustrate how swap credit risk is reduced by both netting and marking to market
- Define swap spread and relate it to credit risk
“Interest Rate Derivative Instruments”
The practitioner should be able to:
- Demonstrate how both a cap and a floor are packages of options on interest rates, and options on fixed income instruments
- Compute the payoff for a cap and a floor, and explain how a collar is created
"Using Credit Derivatives to
Enhance Return and Manage Risk"
The practitioner should be able to:
- Describe the characteristics of a credit default swap, and compare and contrast a credit default swap to a corporate bond
- Explain the advantages of using credit derivatives over other credit instruments
- Explain the use of credit derivatives by the various market participants
- Discuss credit derivatives strategies and how they are used