Dear CFA® Program Level I Candidate, We all thank those of you who have found this series useful and sent in your letters of appreciation.
In this session we will discuss the Commandments and Sins of the Derivatives topic.
- Always remember, FRA payments are discounted using the FLOATING rate. Interest rate options and Swaps payments are NOT discounted.
- Don’t get confused because of the name, a Eurodollar deposit is a Dollar denominated account operating ANYWHERE outside the United States.
- Remember the shortcut: Because Eurodollar contracts are highly standardized, its structure works out in a way that if interest rates change by 1bp, the change in contract value is $25. So in your exam, if you see a question where there is a 3bps change in yield, the contract value changes by 3*25 = $75.
- Don’t get confused between margins in Derivatives and Equity! In case your account balance drops below the maintenance margin, in Derivative, you need to deposit enough money to bring it back to the INITIAL margin.
- Remember this to eliminate option in the exam: The Upper and Lower bounds for a European and American CALL Option are IDENTICAL. The Upper and Lower bounds for a European and American PUT Options are DIFFERENT.
- Don’t forget the important characteristics of these two swaps: for a currency swap, there is an actual loan being made in the two currencies and the payments are NEVER netted. In an equity swap, since equity can have a negative return, it is possible that the fixed payer actually pays floating.
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