[Last Update: Nov 7, 2017]

## Banks

### Types of Banks

• Commercial banks
• Investment banks

### Major Risks Faced by Banks

#### LO 31.1: Identify the major risks faced by a bank.

• credit risk
• market risk
• operational risk

## Insurance Companies and Pension Plans

### Risks Facing Inssurance Companies

• Insufficient funds to satisfy policyholder’s claim
• poor return on investment
• liquidity risk of investments
• credit risk
• operational risk

## Hedging Strategies Using Futures

### Basis Risk

#### LO 36.4: Define cross hedging, and compute and interpret the minimum variance hedge ratio and hedge effectiveness.

• $HR = \rho{\mbox{spot, futures}} \frac{\sigma{\mbox{spot}}}{\sigma_{\mbox{futures}}}$

### Hedging with Stock Index Futures

#### LO 36.5: Compute the optimal number of futures contracts needed to hedge an exposure, and explain and calculate the “tailing the hedge” adjustment.

• # of contracts = $\beta_{\mbox{portfolio}} \frac{\mbox{portfolio value}}{\mbox{futures price * contract multiplier}}$

#### LO 36.6: Explain how to use stock index futures contracts to change a stock portfolio’s beta.

• # of contracts = $(\beta^{} - \beta) \frac{\mbox{portfolio value}}{\mbox{value of futures contract}}$

## Determination of Forward and Future Prices

### Contango and Backwardation

#### LO 38.12: Define and interpret contango and backwardation, and explain how they relation to the cost-of-carry model.

• contango: futures price > current spot price
• backwardation: opposite of the above

## Interest Rate Futures

### Day Count Conventions

#### LO 39.1: Identify the most commonly used day count conventions, describe the markets that each one is typically used in, and apply each to an interest calculation

• T-bond: actual/actual
• corporate bond & municipal bonds: 30/360
• money market instruments: actual/360

### Quotations for T-Bonds

#### LO 39.3: Differentiate between the clean and dirty price for a US Treasury bond; calculate the accrued interest and dirty price on a US Treasury bond.

• dirty price = clean price + accrued interest

### Clean and Dirty Prices

###Quotations for T-Bills

### Duration-based Hedging

#### LO 39.11: Calculate the duration-based hedge ratio and create a duration-based hedging strategy using interest rate functions.

• number of contracts = $-\frac{\mbox{portfolio of value duration of portfolio}}{\mbox{futures value duration of futures}}$

## Mechanics of Options Markets

### Option Types

#### LO 41.1: Describe the types, position variations, and typical underlying assets of optioins.

• Call options
• Put options
• Underlying assets
• stock options
• currency options
• index options

### Stock Options Specifications

#### LO 41.2: Explain the specification of exchange-traded stock option contracts, including that of nonstandard products.

• expiration
• strike prices
• moneyness, time value, and intrinsic value

## Properties of Stock Options

### Six Factors that Affect Option Prices

#### LO 42.1: Identify the six factors that affect an option’s price and describe how these six factors affect the price for both European and American options.

• current stock price
• strike price
• time to maturity
• short-term risk-free interest
• present value of the dividend of the underlying stock
• expected volatility of stock prices

### Computing Option Values Using Put-Call Parity

#### LO 42.3: Explain put-call parity and apply it to the valuation of European and American stock options.

• $c + Xe^{-rT} = S + p$

### Lower Pricing Bounds for an American Call Option on A Nondividend-paying Stock

#### LO 42.4: Explain the early exercise features of American call and put options.

• do not exercise an American call option on nondividend-paying stock prior to expiration

## Corporate Bonds

### Interest Payment Classifications

#### LO 50.3: Describe the main types of interest payment classifications.

• straight-coupon bonds
• zero-coupon bonds
• floating-rate bonds