EFB201 — Financial Markets Revision Notes

Flashcards covering equity return and risk, derivative hedging and speculation, foreign exchange market mechanics, AI's impact on financial analysis, and CFA ethical standards.

Return (Equity)

Calculated as $\frac{P_t}{P_{t-1}} - 1$ or via the log version, representing the gain or loss of an investment over a period.

Systematic Risk

Market-wide, non-diversifiable risk that affects all assets, such as interest rate rises, recessions, or pandemics.

Non-systematic Risk

Also known as idiosyncratic or individual risk; it is firm-specific or industry-specific and can be eliminated through diversification.

Beta ($\beta$)

A measure of an asset's exposure to systematic (market) risk only, where $\beta = 1$ indicates the same risk as the market.

CAPM Formula

$E(R_i) = R_f + \beta_i \times [E(R_m) - R_f]$ where $R_f$ is the risk-free rate and $E(R_m)$ is the expected return on the market portfolio.

Market Risk Premium

The expected return on the market portfolio minus the risk-free rate, expressed as $E(R_m) - R_f$.

Derivative

A financial contract whose value depends on the price of an underlying asset, such as a stock, index, commodity, currency, or interest rate.

Forward Contract

A private OTC agreement to buy or sell an asset at a set price on a future date, featuring symmetric and linear payoffs but carrying counterparty risk.

Futures Contract

An exchange-traded, standardised contract where a clearinghouse eliminates counterparty risk and gains/losses are settled daily through marking to market.

Margin Call

A requirement for a party to top up their account to the initial margin level if the balance falls below the maintenance margin.

Call Option

The right, but not the obligation, to buy an underlying asset at a specified strike price.

Put Option

The right, but not the obligation, to sell an underlying asset at a specified strike price.

In-the-money (ITM)

A state where exercising an option has positive value; for a call, market price $>$ strike; for a put, market price $<$ strike.

Symmetric Payoff

A payoff structure found in forwards and futures where the obligations are equal for both sides and the profit/loss diagram is a straight diagonal line.

Asymmetric Payoff

A payoff structure found in options where the buyer has a right but no obligation, resulting in a 'kink' at the strike price on a payoff diagram.

Covered Call

An income generation strategy involving owning shares and selling a call option on those same shares to collect a premium.

Straddle

A volatility speculation strategy involving the simultaneous purchase of a call and a put at the same strike price and expiry.

Vehicle Currency

A global currency, primarily the USD, used as an intermediary to facilitate trades between two other currencies.

Pip

The smallest unit of price movement in FX, typically equal to $0.0001$ for most pairs and $0.01$ for JPY pairs.

FX Swap

A transaction involving two legs: a buy/sell at the spot rate today and a reverse transaction at a pre-agreed forward rate at a later date.

Covered Interest Rate Parity (CIP)

A no-arbitrage condition expressed by the formula $F = S \times \frac{1 + i_d}{1 + i_f}$, suggesting domestic investment returns should equal foreign investment returns hedged with a forward contract.

Hedge Ratio ($h$)

The ratio of the notional value of a forward contract to the market value of the foreign asset; $h = 1.0$ indicates a fully hedged position.

Sell-side Analyst

Analysts working for investment banks whose reports are distributed to numerous external clients.

Buy-side Analyst

Analysts working for fund managers or pension funds whose reports remain internal to the organisation.

Hallucination (AI)

An AI failure mode where the system generates fluent but entirely fabricated facts, figures, and sources.

Commoditisation (AI)

The convergence of summaries and insights due to widespread AI use, which eliminates personal speed as a competitive edge.

Material Nonpublic Information

Inside information that CFA Standards prohibit members from trading on or causing others to trade on.

Suitability

The CFA requirement to assess a client's risk tolerance, return objectives, and constraints before making investment recommendations.

LIBOR

A global benchmark interest rate that was the subject of a major scandal involving banks manipulating submitted rates for financial gain.