describe the process of short selling. define the theoretical fair value of an asset and relate it to the concept of market efficiency. discuss and relate the concepts of arbitrage and the law of one price. describe how and why risk is transferred from hedgers to speculators in derivative markets.
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describe the process of short selling.
define the theoretical fair value of an asset and relate it to the concept of market efficiency.
discuss and relate the concepts of arbitrage and the law of one price.
describe how and why risk is transferred from hedgers to speculators in derivative
markets.
Step by step
Solved in 5 steps
- Define the terms, or give short explanations. -short sale/short selling -speculation -speculator -swap -swaption -theoretical fair value (of an asset) -underlying assetDefine the terms, or give short explanations. -arbitrage -business risk -call -cash market/spot market -derivative/derivative market -derivative securityIf you have long position in one asset and you want to hedge the risk of price drop in that asset while still having the upside in case the asset price goes up, what sort of derivative trading will you do? Explain in brief with payoff diagram.
- Which of the following is not a characteristic of an efficient market? Investors can frequently make profits by predicting asset market prices that are different from intrinsic values. The market value of all securities at any one instant in time fully reflect all available information. Investors act rationally. The forces of demand and supply work to maintain that the security's market price and its intrinsic value are in equilibrium.How are derivatives valued on the balance sheet? How is the adjustment to fair value recorded differently for a cash flow hedge versus a fair value hedge? That is, how does the fair value adjustment of each type of hedge affect current period net income and the accounting equation? What are the three criteria that must be met for a derivative to be classified as a hedge? Once entities decide to buy or sell derivatives to hedge economic risks, they then need to decide whether they want to use hedge accounting; it is an election, not a requirement, even when the derivatives are for the economic purpose of hedging. This election is reminiscent of inventory accounting. Just like when a company selects an inventory method, a company is not required to select the accounting method (LIFO, FIFO, weighted average, specific unit) that most closely corresponds with the physical movement of inventory, although they are free to do so. If entities decide to elect hedge accounting, the following…Which of the following best describes the terms 'long position' and 'short position' in trading? A long position means expecting the asset's price to rise, and a short position means expecting it to fall. A short position is when a trader borrows an asset to sell, hoping to buy it back at a lower price, while a long position is when a trader buys an asset expecting its price to rise. A long position is when a trader sells an asset immediately, while a short position is holding it for a longer period. A long position indicates selling an asset, while a short position indicates buying it.
- Under which circumstances can the speculator gain a profit and what is the risk of carry trades?According to Capital Asset Pricing theory (CAPM), in a competitive marketplace: Group of answer choices A. only systematic risk is rewarded. B. only diversifiable risk is rewarded. C. all types of risks are rewarded. D. no risk is rewarded.A fair value hedge differs from a cash flow hedge because a fair value hedge Select one: a.records gains or losses in the value of the derivative directly to earnings of the company. b.defers the gains or losses in the value of the derivative using Other Comprehensive Income. c.cannot be used for firm purchase or sales commitments. d.is not recorded unless it is a highly-effective hedge.
- A primary market is: -the financial market where new security is sold for the first time. -the financial market where previously issued securities are sold the second time. -a product market where previously issued securities are resold (traded). -product market where products are sold for the second time Explain the correct option answer well.The Capital Asset Pricing Model (CAPM) considers which type of risk in pricing the expected returns and risk of securities? A) Systemic risk. B) Unsystemic risk. C) Diversifiable risk. D) Non-market risk.a)describe the role of forward markets and futures markets in price discovery. b)discuss three major operational advantages provided by derivative markets. c)distinguish between derivative markets and gambling on the basis of benefits to society. d)describe the three ways in which derivatives can be misused.