Temasek Informatics & IT School

Advanced Derivatives (ADER)
AY 2007/2008 Oct Semester 

Module 1
Derivatives Concept & Exchange Traded Derivatives Tutorial

1. Answer True / False for the following questions

1. Futures markets typically work best when there are few speculators. False
2. Rather than having an expiration date like an option, a future contract has
a delivery date. True
3. A business that needs a particular commodity in the near future could
logically use a short hedge to get it. False, use long hedge
4. The futures market is not designed to provide protection against crop
failure. True
5. Basis is the difference between the futures price and the cash price. True
6. Futures contracts are mark to market weekly. False, MTM daily
7. Forward contracts are mark to market in the same manner as futures
contracts. False, Forward contracts are not MTM
8. An index option is cash settled. True
9. Option premium is usually greater than option price. False, both the same
10. Writing a call is economically equivalent to buying a put. False, Owner of
an option has the right to do something, while the writer has an
obligation to perform if the option owners exercise.

2. Risk in relation to any activities in the financial markets including derivatives

market can be categorized broadly into market, credit and operational risk.
Briefly explain these three risks and the following potential risk situation in a
derivatives operation: Delivery; Close Outs; Collateral; Exercise of options;
Position Limits; Margin; Reconciliation

a) Market risk – risk of financial loss due to trading errors, liquidity issues,
adverse market movements or breaches of market rules and regulations.

b) Credit risk – risk of financial loss due to failure of a counterparty. This loss can
be failure to receive either cash or assets or both and the cost of replacement.

c) Operational risk – risk of financial loss as a result of inadequate or failed

internals processes, people and systems or from external events

d) Operational risks in derivatives operations

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 3. What is the disadvantage of the ETD market?

 Price change in the contract does not match the price change in the position

4. In options on futures, who bears the risk of loss – buyer or seller AND who
should the Exchange make margin calls on?

 Buyers has limited risk – lose the premium only

 Seller bears the risk of loss.
 Margin calls are on the sellers

5. When should a buyer of a call option on futures exercise his/her rights?

When the buyer wishes to acquire a long position in the underlying futures
contract i.e. her/she believes the futures contract prices would increase in value.
(when strike price is lower than underlying price)

6. Source via internet for the contract specification detail of futures and options on
futures for the following ETD products. Compare and contrast the futures and
options contracts.
a. Eurodollar Futures
b. Light, Sweet Crude Oil futures
c. Natural Gas Futures

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