Study Session #17
Learning Outcome Statements
(Last revised 12/19/04)

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A. “Derivative Markets and Instruments”
a) define a derivative;
b) differentiate between exchange-traded and over-the-counter derivatives;
c) define a forward commitment and identify the types of forward commitments;
d) describe the basic characteristics of forward contracts, futures contracts, and swaps;
e) define a contingent claim and identify the types of contingent claims;
f) describe the basic characteristics of options and distinguish between an option to buy (call) and
an option to sell (put);
g) discuss the purposes and criticisms of derivative markets;
h) explain the concept of arbitrage and the role it plays in determining prices and in promoting
market efficiency.
B. “Forward Markets and Contracts”
a) discuss the differences between the positions held by the long and short parties to a forward contract in
terms of delivery/settlement and default risk;
b) describe the procedures for settling a forward contract at expiration;
c) discuss how a party to a forward contract can terminate a position prior to expiration and how
credit risk is affected by the way in which a position is terminated;
d) differentiate between a dealer and an end user of a forward contract;
e) describe the characteristics of equity forward contracts;
f) describe the characteristics of forward contracts on zero-coupon and coupon bonds;
g) explain the characteristics of the Eurodollar time deposit market;
h) define LIBOR and Euribor;
i) describe the characteristics of forward rate agreements (FRAs);
j) calculate the payment at expiration of an FRA and explain each of the component terms;
k) describe the characteristics of currency forward contracts.
C. “Futures Markets and Contracts”
a) identify the institutional features that distinguish futures contracts from forward contracts;
b) describe the characteristics of futures contracts;
c) differentiate between margin in the securities markets and margin in the futures markets;
d) describe how a futures trade takes place;
e) describe how a futures position may be closed out (i.e., offset) prior to expiration;
f) define initial margin, maintenance margin, variation margin, and settlement price;
g) describe the process of marking to market;
h) compute the margin balance, given the previous day’s balance and the new futures price;
i) explain price limits, limit move, limit up, limit down, and locked limit;
j) describe how a futures contract can be terminated by a close-out (i.e., offset) at expiration,
delivery, an equivalent cash settlement, or an exchange-for-physicals;
k) explain delivery options in futures contracts;
l) distinguish among scalpers, day traders, and position traders;
m) describe the characteristics of the following types of futures contracts: Treasury bill, Eurodollar,
Treasury bond, stock index, and currency.
D. “Option Markets and Contracts”
a) identify the basic elements and describe the characteristics of option contracts;
b) define European option, American option, moneyness, payoff, intrinsic value, and time value;
c) differentiate between exchange-traded options and over-the-counter options;

d) identify the different types of options in terms of the underlying instruments;
e) compare and contrast interest rate options to forward rate agreements (FRAs);
f) explain how option payoffs are determined, and show how interest rate option payoffs differ
from the payoffs of other types of options;
g) define interest rate caps and floors;
h) identify the minimum and maximum values of European options and American options;
i) illustrate how the lower bounds of European calls and puts are determined by constructing
portfolio combinations that prevent arbitrage, and calculate an option’s lower bound;
j) determine the lowest prices of European and American calls and puts based on the rules for
minimum values and lower bounds;
k) illustrate how a portfolio (combination) of options establishes the relationship between options
that differ only by exercise price;
l) explain how option prices are affected by the time to expiration of the option;
m) explain put-call parity for European options, given the payoffs on a fiduciary call and a protective
put;
n) explain the relationship between American options and European options in terms of the lower
bounds on option prices and the possibility of early exercise;
o) explain how cash flows on the underlying asset affect put-call parity and the lower bounds of
option prices;
p) identify the directional effect of an interest rate change on an option’s price.
E. “Swap Markets and Contracts”
a) describe the characteristics of swap contracts;
b) explain how swaps are terminated;
c) define and give examples of currency swaps;
d) calculate the payments on a currency swap;
e) define and give an example of a plain vanilla interest rate swap;
f) calculate the payments on an interest rate swap;
g) define and give examples of equity swaps;
h) calculate the payments on an equity swap.
F. “Risk Management Applications of Option Strategies”
a) determine the value at expiration, profit, maximum profit, maximum loss, breakeven underlying
price at expiration, and general shape of the graph of the strategies of buying and selling calls and
buying and selling puts, and explain each strategy’s characteristics;
b) determine the value at expiration, profit, maximum profit, maximum loss, breakeven underlying
price at expiration, and general shape of the graph of the covered call strategy and the protective
put strategy, and explain each strategy’s characteristics.

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