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1. Diversifiable Risk a risk unrelated to other risks.

a. E.g. risk that a lightning strike will cause a factory to burn down is diversifiable, since its
likely many investors share small piece of risk.
2. Nondiversifiable Risk Risk that does not vanish when spread across many investors.
a. E.g. risk of a stock market crash.
3. Lease Rate Payments made to lender when borrowing an asset.
a. e.g. Dividends on short-sold stock.
4. Stock Index Average price of a group of stocks.
5. Marking to Market The procedure of revaluing a portfolio or position to reflect current market
prices.
6. Risk Averse An individual who is unwilling to take a fair bet.
7. Covered Call Owning an asset and simultaneously selling a call option. Limited profitability if
index rises, but losses are offset by premium earned from selling call. Looks like a written put.
8. Naked Writing When the writer of an option does not have a position in the asset.
9. Put-Call Parity Call(K,T) Put(K,T) + PV(K) = PV(F
0,T
).
a. The cost of a long forward is just buying the asset at time T at the forward price (F
0,T
).
The present value of this must equal the present value of the cost of a synthetic long
forward (payoffs are the same). For a synthetic long forward, we agree to buy at the
strike price K at time T, and the net premium is Call(K,T) Put(K,T) (we buy a call, write a
premium).
b. If equation does not hold, there is an opportunity for arbitrage.
10. Futures Contracts are essentially exchange-traded forward contracts. Traded electronically or in
trading pits with buyers and sellers (open outcry).
a. How futures contracts differ from forward contracts:
i. Forward contracts are settled at expiration, futures contracts are settled daily.
ii. As a result of daily settlement, futures contracts are more liquid it is possible
to offset an obligation on a given date by entering into the opposite position.
iii. Over-the-counter forward contracts can be customized to suit the buyer or
seller, whereas futures contracts are standardized.
iv. Futures contracts carry less credit risk as a result of being settled daily.
v. There are typically daily price limits (a price that triggers a temporary halt in
trading).
11. Relationship between Forward Price and Future stock price:
a. E(S
T
) = F
0,T
*e
(expected return on stock interest rate)

b. Stock carries more risk than interest, so expected stock price is larger than forward
price.
12. Relationship between Forward Price and Futures price:
a. If interest rates are not random, then forward and futures prices are the same.
b. If Corr(Interest rates, Futures Price) > 0, then Futures price > Forward price
c. If Corr(Interest rates, Futures Price) < 0, then Futures price < Forward price
13. Implied repo rate: the continuous annual rate of interest of a synthetic bond (entering a long
forward for one share of stock, and shorting e
-delta *t
shares of stock. We cover position by
paying F
0, T
for the stock. Yield rate is implied repo rate)
14.

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