CISI CMP Sec/Deriv — CISI Capital Markets Programme - Securities / Derivatives Cheat Sheet
Cheat sheet: exam reference for the Chartered Institute for Securities & Investment CISI CMP Sec/Deriv exam: securities, derivatives, trading, settlement, valuation, risk, and conduct decision points.
Use the tables for a quick pre-exam check. Expand a topic’s notes for explanations, examples, and additional distinctions.
Scope and study context
- Product mechanics: equities, bonds, money-market instruments, repos, futures, options, swaps, warrants, and structured exposures.
- Exam-style distinctions: exchange vs OTC, agency vs principal, clean vs dirty price, forward vs futures, option buyer vs writer, hedging vs speculation.
- Calculation triggers: yield, accrued interest, TERP, option payoff, futures hedge size, duration-based price sensitivity.
- Risk and conduct vocabulary: market abuse, conflicts, suitability, client assets, counterparty risk, liquidity risk, and settlement risk.
For best results:
- Read the tables and decision rules first.
- Attempt original practice questions by topic.
- Review detailed explanations for every miss, guess, or slow answer.
- Return to this page to patch weak areas before full mock exams.
Core product map
| Area | Economic nature | Typical cash flows | Main risks | Exam cue |
|---|---|---|---|---|
| Ordinary shares | Ownership/residual claim | Dividends if declared; capital gain/loss | Market, dividend, liquidity, issuer-specific, voting/control dilution | Highest participation in upside; lowest priority on insolvency |
| Preference shares | Hybrid equity-like income claim | Fixed or variable dividend, often priority over ordinary shares | Dividend deferral, interest-rate sensitivity, issuer risk, liquidity | Equity legally, but income behavior can resemble debt |
| Fixed-rate bonds | Debt/contractual claim | Coupon plus redemption principal | Interest-rate, credit, inflation, liquidity, call risk | Price falls when yield rises |
| Floating-rate notes | Debt with reset coupon | Coupon linked to reference rate plus/minus margin | Credit, spread, reset, benchmark, liquidity | Less price sensitivity to rate moves than fixed-rate bonds |
| Zero-coupon bonds | Debt sold at discount | No interim coupon; redemption at maturity | High duration, credit, reinvestment absent but price volatility high | Return mainly from discount accretion |
| Money-market instruments | Short-term debt/liquidity instruments | Discount or short coupon | Credit, liquidity, rollover, rate risk | Short maturity reduces price volatility but not credit risk |
| Repo / reverse repo | Collateralized financing | Cash interest via repo rate; collateral transfer | Counterparty, collateral, margin/haircut, operational | “Repo” perspective depends on whether party gives or receives cash |
| Exchange-traded futures | Standardized derivative obligation | Daily variation margin; final cash/physical settlement | Leverage, basis, liquidity, margin call | Futures are obligations, not rights |
| Forwards | OTC derivative obligation | Settlement at maturity, usually no daily margin unless collateralized | Counterparty, liquidity, settlement, valuation | Custom terms; higher bilateral counterparty focus |
| Options | Right for buyer, obligation for writer | Buyer pays premium; writer receives premium | Premium loss for buyer; potentially large writer loss | Asymmetric payoff; time value matters |
| Swaps | OTC exchange of cash-flow streams | Net periodic payments | Counterparty, rate/FX/credit, collateral, basis | No principal exchange in many interest-rate swaps |
| Warrants | Long-dated option-like securities | Premium/market price; possible exercise | Issuer, dilution, leverage, liquidity | Usually issued by company or financial institution |
| Structured products | Packaged securities with embedded derivatives | Formula-linked coupons/redemption | Issuer credit, complexity, liquidity, derivative exposure | Payoff may not match simple bond or equity behavior |
Market structure and roles
Primary vs secondary markets
| Feature | Primary market | Secondary market |
|---|---|---|
| Purpose | Issuer raises capital | Investors trade existing securities |
| Cash flow | Investor funds go to issuer, less costs | Cash flows between buyers and sellers |
| Common examples | IPO, placing, rights issue, bond issue | Exchange trade, OTC block trade |
| Price formation | Bookbuild, auction, fixed offer, underwriting | Order book, quote-driven market, negotiated trade |
| Key risk | Issue pricing, allocation, disclosure, underwriting | Liquidity, execution, settlement, market impact |
Notes and examples
Participant roles
| Participant | Function | High-yield distinction |
|---|---|---|
| Issuer | Raises capital through securities | Responsible for continuing disclosures where applicable |
| Investor | Provides capital or takes exposure | May be retail, professional, institutional, or eligible counterparty depending on regime |
| Broker | Acts as agent for client | Earns commission; does not normally take position risk as principal |
| Dealer | Trades as principal | Earns spread/mark-up; takes inventory and market risk |
| Market maker | Continuously quotes buy/sell prices | Provides liquidity but manages spread and inventory risk |
| Investment bank | Advises, structures, underwrites, distributes | Can face conflicts between issuer and investor roles |
| Exchange / trading venue | Centralized trading facility | Transparent order rules and standardized access |
| OTC market | Bilateral or dealer-intermediated trading | More customization; less centralized transparency |
| CCP | Central counterparty to cleared trades | Novation reduces bilateral counterparty risk but concentrates clearing risk |
| CSD / settlement system | Records ownership transfer and settlement | Finality, delivery-versus-payment, custody links |
| Custodian | Safekeeping and asset servicing | Handles income, corporate actions, tax documentation, reporting |
| Registrar / transfer agent | Maintains issuer shareholder register | Important for legal ownership and entitlement records |
Trading and order terminology
| Term | Meaning | Exam trap |
|---|---|---|
| Bid price | Price at which dealer/market is willing to buy | Client selling usually receives bid |
| Offer / ask price | Price at which dealer/market is willing to sell | Client buying usually pays offer |
| Bid-offer spread | Difference between bid and offer | Wider spread implies higher transaction cost/lower liquidity |
| Market order | Execute immediately at best available price | Execution likely; price not guaranteed |
| Limit order | Execute only at limit price or better | Price protected; execution not guaranteed |
| Stop order | Triggered when market reaches stop level | Often becomes market order after trigger unless stop-limit |
| Stop-limit order | Stop trigger plus limit price | May not execute in fast markets |
| Day order | Valid only for trading day/session | Unexecuted portion normally expires |
| Good-till-cancelled | Remains active until cancelled/expiry rule | Candidate should not assume indefinite validity without venue rule |
| Fill-or-kill | Execute entire order immediately or cancel | Not the same as partial fill |
| Iceberg order | Displays only part of total size | Used to reduce market impact |
| Auction | Orders matched at single price | Opening/closing auctions concentrate liquidity |
| Continuous trading | Orders matched throughout session | Order priority and spread matter |
| Principal trade | Firm trades against client | Conflict/spread disclosure issues |
| Agency trade | Firm arranges trade for client | Commission and best execution focus |
Equity securities and corporate actions
Share types and rights
| Security | Key features | Investor use | Common trap |
|---|---|---|---|
| Ordinary share | Voting rights, residual claim, variable dividends | Growth, ownership, voting participation | Dividend is not contractual |
| Non-voting share | Economic exposure without vote | Capital participation without control | May trade at discount to voting shares |
| Preference share | Priority dividend and capital over ordinary shares | Income-oriented exposure | Preference dividend may still be deferrable depending on terms |
| Cumulative preference share | Missed dividends accumulate | Stronger income claim than non-cumulative | Accumulation does not remove issuer credit risk |
| Participating preference share | May share additional profits | Hybrid income/upside | Terms drive payoff; do not assume ordinary-like upside |
| Redeemable preference share | Issuer may redeem or must redeem | Defined exit/capital structure tool | Call/redemption feature affects price |
| Treasury share | Issuer’s own share held by company | Buyback/capital management | Usually no voting/dividend rights while held as treasury stock |
| Depositary receipt | Certificate representing foreign shares | Cross-border access | Holder has DR exposure; local share rights may be indirect |
Notes and examples
Equity valuation and performance formulas
\[ \text{Dividend yield}=\frac{\text{Annual dividend per share}}{\text{Share price}}\times100 \]\[ \text{EPS}=\frac{\text{Profit attributable to ordinary shareholders}}{\text{Weighted average ordinary shares}} \]\[ \text{P/E ratio}=\frac{\text{Share price}}{\text{Earnings per share}} \]\[ \text{Holding-period return}=\frac{\text{Income}+\text{Ending value}-\text{Beginning value}}{\text{Beginning value}}\times100 \]High-yield interpretation:
- High P/E may indicate growth expectations, overvaluation, or temporarily low earnings.
- Dividend yield rises when dividend increases or price falls; a high yield can signal distress.
- EPS dilution can occur after new share issues, conversion of convertibles, or warrant exercise.
- Total return includes income and capital change; price return excludes income.
Corporate actions
| Corporate action | What happens | Economic effect | Candidate cue |
|---|---|---|---|
| Cash dividend | Company distributes cash to shareholders | Share price typically adjusts downward around ex-dividend date | Dividend reduces company cash |
| Scrip dividend | Shareholder receives shares instead of cash | More shares; cash retained by issuer | May dilute if not all shareholders participate equally |
| Rights issue | Existing shareholders offered new shares, usually at discount | Raises capital; protects pre-emption if taken up | Non-participation can dilute ownership/value |
| Bonus / capitalization issue | Free additional shares issued from reserves | No new cash; price adjusts for larger share count | Investor wealth unchanged initially |
| Stock split | Each share split into more shares | Lower price per share, same total value initially | Improves affordability/liquidity; not value creation itself |
| Consolidation / reverse split | Fewer shares at higher price | Same total value initially | Does not fix weak fundamentals by itself |
| Share buyback | Company repurchases own shares | Reduces share count; may improve EPS | Can signal surplus cash or lack of growth projects |
| Tender offer | Offer to buy shares, often at premium | Control/ownership change possible | Consider acceptance conditions and offer premium |
| Takeover offer | Acquirer seeks control of target | Cash, shares, or mixed consideration | Regulatory and shareholder approval conditions may apply |
Rights issue and TERP
Use when an exam question gives a rights ratio and subscription price. \(P_\text{cum}\) is the share price before the shares go ex-rights.
\[ \text{TERP}=\frac{(N_\text{old}\times P_\text{cum})+(N_\text{new}\times P_\text{sub})}{N_\text{old}+N_\text{new}} \]\[ \text{Value per existing share right}=P_\text{cum}-\text{TERP} \]Where needed, convert between “value per existing share right” and “value of rights required to buy one new share” using the stated rights ratio.
TERP traps:
- TERP is theoretical; market price can differ.
- A rights issue raises cash; a bonus issue does not.
- A discounted subscription price is not a free gain because the ex-rights price adjusts.
- If a shareholder does not take up or sell rights, value may be lost.
Debt securities and money-market instruments
Bond vocabulary
| Term | Meaning | Exam cue |
|---|---|---|
| Nominal / par / face value | Amount on which coupon is calculated and usually redeemed | Coupon rate applies to nominal, not market price |
| Coupon | Contractual interest rate or amount | Fixed coupon bond price moves inversely with yields |
| Maturity | Final repayment date | Longer maturity generally means higher duration |
| Clean price | Quoted price excluding accrued interest | Most bond quotes are clean |
| Dirty price | Total settlement price including accrued interest | Buyer pays dirty price |
| Accrued interest | Interest earned since last coupon date | Buyer compensates seller at settlement |
| Yield to maturity | Discount rate equating price to future cash flows | Assumes holding to maturity and reinvestment assumptions |
| Current yield | Annual coupon divided by price | Ignores capital gain/loss to redemption |
| Credit spread | Extra yield over lower-risk benchmark | Compensates for credit/liquidity/risk premium |
| Senior debt | Higher repayment priority | Lower expected loss than subordinated debt, all else equal |
| Subordinated debt | Lower ranking on insolvency | Higher yield demanded |
| Secured bond | Backed by collateral/security | Collateral quality matters |
| Callable bond | Issuer can redeem early | Investor faces reinvestment risk if called |
| Puttable bond | Investor can require redemption | Investor protection; issuer pays via lower yield |
| Convertible bond | Bond plus option to convert to shares | Debt downside with equity upside, subject to terms |
| Index-linked bond | Cash flows linked to inflation/index | Protects real value depending on structure |
| FRN | Coupon resets to reference rate plus margin | Lower duration, but credit spread risk remains |
Notes and examples
Bond price, yield, and risk relationships
| Change | Fixed-rate bond price impact | Why |
|---|---|---|
| Market yield rises | Price falls | Existing coupon less attractive |
| Market yield falls | Price rises | Existing coupon more attractive |
| Coupon rate higher | Lower duration, all else equal | More cash received earlier |
| Maturity longer | Higher duration, all else equal | Cash flows further in future |
| Credit spread widens | Price falls | Required return increases |
| Issuer credit improves | Price rises / spread tightens | Required credit premium falls |
| Call becomes likely | Upside price may be capped | Investor may be redeemed early |
| Liquidity worsens | Price usually falls / spread widens | Investors demand liquidity premium |
Core bond formulas
\[ \text{Accrued interest}=\text{Coupon for period}\times\frac{\text{Days since last coupon}}{\text{Days in coupon period}} \]\[ \text{Dirty price}=\text{Clean price}+\text{Accrued interest} \]\[ P=\sum_{t=1}^{n}\frac{C_t}{(1+y)^t}+\frac{M}{(1+y)^n} \]\[ \text{Current yield}=\frac{\text{Annual coupon}}{\text{Clean price}}\times100 \]\[ \text{Approximate YTM}= \frac{\text{Annual coupon}+\frac{\text{Redemption value}-\text{Price}}{\text{Years to maturity}}} {\frac{\text{Redemption value}+\text{Price}}{2}}\times100 \]\[ D_\text{mod}=\frac{D_\text{Mac}}{1+y/m} \]\[ \frac{\Delta P}{P}\approx-D_\text{mod}\Delta y \]Formula traps:
- Use the day-count convention supplied in the question.
- Clean price is not cash paid; dirty price is the settlement amount.
- Current yield ignores redemption gain/loss.
- Approximate duration price change is linear; large yield moves need convexity awareness.
- Bond prices can exceed 100 when coupon is above current yield.
Money-market and repo quick reference
| Instrument | Description | Return form | Key risk |
|---|---|---|---|
| Treasury bill | Short-term government discount security | Issued below par, redeemed at par | Rate/liquidity; low but not zero sovereign risk depending issuer |
| Commercial paper | Short-term unsecured corporate debt | Discount or interest-bearing | Issuer credit and rollover risk |
| Certificate of deposit | Negotiable bank deposit instrument | Interest-bearing or discount | Bank credit and liquidity |
| Banker’s acceptance | Bank-guaranteed short-term instrument | Discount | Bank and trade-related credit risk |
| Repo | Sale of security with agreement to repurchase | Repo interest paid by cash borrower | Collateral, haircut, counterparty, settlement |
| Reverse repo | Purchase of security with agreement to resell | Cash lender earns repo rate | Same transaction viewed from cash provider side |
| Securities lending | Lender lends securities against collateral | Lending fee/rebate | Recall, collateral, counterparty, operational |
Repo perspective trap:
- The party doing a repo usually sells securities and receives cash: economically a collateralized borrowing.
- The party doing a reverse repo usually gives cash and receives securities: economically a collateralized lending.
- A haircut protects the cash lender against collateral value decline.
Derivatives reference
Exchange-traded vs OTC derivatives
| Feature | Exchange-traded | OTC |
|---|---|---|
| Contract terms | Standardized | Customized |
| Trading | On exchange/venue | Bilateral or dealer-intermediated |
| Clearing | Often CCP-cleared | Bilateral or cleared depending product/rules |
| Counterparty risk | Reduced by CCP and margining | Managed by credit assessment, collateral, netting, documentation |
| Liquidity | Often better in standard maturities | Can be lower; depends on dealer market |
| Transparency | More visible prices/volumes | Less transparent |
| Flexibility | Lower | Higher |
| Documentation | Exchange rules | Master agreements, confirmations, collateral terms |
Notes and examples
Instrument selection
| Need | Product often used | Why | Key caution |
|---|---|---|---|
| Lock in future buy/sell price | Forward or futures | Linear exposure with no upfront premium, aside from margin/collateral | Obligatory payoff; adverse and favorable moves both locked |
| Hedge existing long equity exposure | Sell futures or buy puts | Futures reduce downside and upside; puts retain upside | Option premium can be material |
| Gain upside with limited loss | Buy call option | Maximum loss is premium | Time decay and volatility pricing |
| Generate income from holdings | Covered call | Premium received | Upside capped; still downside on underlying |
| Protect against rate rise for borrower | Pay fixed in swap, buy FRA-type protection, or use rate futures/options | Locks or limits floating-rate cost | Basis and hedge mismatch |
| Benefit from falling rates | Receive fixed in swap or buy bond exposure | Fixed-rate assets rise when rates fall | Duration and credit risk remain |
| Customize cash-flow exchange | OTC swap | Tailored dates, notionals, indices | Counterparty and collateral terms |
| Leverage view on underlying | Futures, options, warrants, CFDs | Lower capital outlay than cash position | Losses can be rapid; margin calls possible |
| Hedge FX transaction | FX forward/swap/option | Matches currency amount and date | Forward points and option premium matter |
| Take credit exposure | Credit derivative or credit-linked structure | Separates credit risk from funding | Documentation and credit event definitions matter |
Linear derivative payoff
\[ \text{Long forward/futures payoff}=S_T-F_0 \]\[ \text{Short forward/futures payoff}=F_0-S_T \]Interpretation:
- Long futures/forward: benefits if underlying price rises.
- Short futures/forward: benefits if underlying price falls.
- Futures are marked to market through variation margin; forwards commonly settle at maturity unless collateralized.
- Basis risk arises when the hedge instrument does not move perfectly with the hedged exposure.
Options quick reference
| Term | Call option | Put option |
|---|---|---|
| Buyer’s right | Buy underlying | Sell underlying |
| Writer’s obligation | Sell underlying if exercised | Buy underlying if exercised |
| Buyer market view | Bullish or wants upside protection | Bearish or wants downside protection |
| Maximum buyer loss | Premium | Premium |
| Writer risk | Potentially large if uncovered | Large if underlying falls sharply |
| In the money | Underlying price greater than strike | Strike greater than underlying price |
| At the money | Underlying near strike | Underlying near strike |
| Out of the money | Underlying price less than strike | Strike less than underlying price |
| Delta sign | Positive | Negative |
| Common hedge use | Cap purchase price; upside exposure | Floor sale value; portfolio insurance |
Option style, Greeks, and volatility
| Concept | Meaning | Exam cue |
|---|---|---|
| European style | Exercise only at expiry | Style affects exercise timing, not geography |
| American style | Exercise any time up to expiry | More flexible; can be more valuable |
| Bermuda style | Exercise on specified dates | Between European and American |
| Intrinsic value | Immediate exercise value | Cannot be negative |
| Time value | Premium above intrinsic value | Falls as expiry approaches, all else equal |
| Implied volatility | Volatility embedded in option price | Higher implied volatility increases option premiums |
| Delta | Price sensitivity to underlying | Hedge ratio approximation |
| Gamma | Sensitivity of delta to underlying | Long options usually positive gamma |
| Theta | Sensitivity to time passing | Long options usually negative theta |
| Vega | Sensitivity to volatility | Long calls and puts usually positive vega |
| Rho | Sensitivity to interest rates | Usually less dominant for short-dated equity options |
| Open interest | Outstanding contracts not closed/exercised | Not the same as trading volume |
Forward pricing and parity
For a simple continuously compounded cost-of-carry model, where \(u\) represents storage/financing costs and \(y\) represents income yield:
\[ F_0=S_0e^{(r+u-y)T} \]For a non-dividend-paying European call and put with same strike and expiry:
\[ C-P=S_0-Ke^{-rT} \]If known dividends apply, replace the spot price with spot less the present value of dividends in the parity relationship.
Parity traps:
- Put-call parity applies to European options under stated assumptions.
- American exercise features and dividends can change relationships.
- Higher volatility increases both call and put value, not just calls.
- A forward price is not a forecast; it is a no-arbitrage pricing relationship under assumptions.
Swaps and rate derivatives
| Product | Basic structure | User need | Exam trap |
|---|---|---|---|
| Interest-rate swap | Exchange fixed-rate and floating-rate cash flows | Convert fixed exposure to floating or vice versa | Notional is usually reference amount, not exchanged |
| Fixed-rate payer swap | Pays fixed, receives floating | Benefits when floating rates rise relative to fixed rate | Similar to being short fixed-rate bond exposure |
| Fixed-rate receiver swap | Receives fixed, pays floating | Benefits when rates fall | Similar to being long fixed-rate bond exposure |
| Currency swap | Exchange interest and sometimes principal in different currencies | Long-term FX/funding management | Principal exchange may occur at start/end depending structure |
| Equity swap | Exchange equity return for interest rate or other return | Synthetic equity exposure or hedge | Counterparty and dividend treatment matter |
| Credit default swap | Protection buyer pays premium; seller compensates after defined credit event | Hedge or take credit risk | Credit event and settlement definitions are critical |
| FRA | Agreement on future interest rate for a period | Lock future borrowing/lending rate | Settlement is normally at start of loan period on discounted basis |
Hedge sizing formulas
For an equity index futures hedge:
\[ \text{Number of contracts}= \frac{\text{Portfolio value}\times\beta} {\text{Futures price}\times\text{Contract multiplier}} \]For an approximate duration hedge using bond futures:
\[ \text{Number of contracts}\approx \frac{\text{Portfolio value}\times\text{Portfolio modified duration}} {\text{Futures contract value}\times\text{Futures modified duration}} \]Direction:
- Long cash equity or bond exposure and want to reduce market risk: usually sell futures.
- Need to buy asset later and fear price rise: usually buy futures.
- Want downside protection while keeping upside: buy puts instead of selling futures.
- Want income and accept capped upside: write covered calls.
Derivatives: high-yield review
A derivative derives value from an underlying such as an equity, bond, interest rate, index, commodity, currency, or credit event. Derivatives are used for hedging, speculation, arbitrage, yield enhancement, and risk transfer.
Core derivative types
| Derivative | Obligation/right | Key use | Main trap |
|---|---|---|---|
| Forward | Obligation to buy/sell at future date at agreed price | Custom hedge | OTC counterparty risk |
| Future | Standardised exchange-traded forward-style contract | Hedging/speculation | Margin is not the same as premium |
| Call option | Right to buy underlying | Upside exposure | Buyer has right, not obligation |
| Put option | Right to sell underlying | Downside protection | Seller has obligation if exercised |
| Swap | Exchange of cash flows | Rate/currency/credit exposure management | Notional is usually not exchanged in plain interest-rate swaps |
| Contract for difference-style exposure | Cash-settled price difference exposure where applicable | Leveraged trading | Losses can exceed initial outlay depending on terms |
Long and short positions
| Position | Wants price to… | Maximum loss idea |
|---|---|---|
| Long underlying | Rise | Price paid, if value falls to zero |
| Short underlying | Fall | Potentially large/unlimited |
| Long call | Rise above strike plus premium | Premium paid |
| Short call | Stay at/below strike | Potentially large/unlimited |
| Long put | Fall below strike less premium | Premium paid |
| Short put | Stay at/above strike | Large, down to underlying near zero |
| Long future | Rise | Losses if price falls, settled through margin |
| Short future | Fall | Losses if price rises, settled through margin |
Option payoff essentials
At expiry:
\[ \text{Call payoff} = \max(S - K, 0) \]\[ \text{Put payoff} = \max(K - S, 0) \]Where \(S\) is the underlying price at expiry and \(K\) is the strike price.
Profit also includes premium:
- Long call profit = call payoff − premium paid.
- Short call profit = premium received − call payoff.
- Long put profit = put payoff − premium paid.
- Short put profit = premium received − put payoff.
Breakeven rules:
| Strategy | Breakeven at expiry |
|---|---|
| Long call | Strike + premium |
| Short call | Strike + premium |
| Long put | Strike − premium |
| Short put | Strike − premium |
The same breakeven number applies to the long and short side of the same option, but the profit direction is opposite.
Option moneyness
| Option | In the money | At the money | Out of the money |
|---|---|---|---|
| Call | Underlying price > strike | Underlying price ≈ strike | Underlying price < strike |
| Put | Underlying price < strike | Underlying price ≈ strike | Underlying price > strike |
Common trap: “In the money” does not automatically mean profitable after premium. It means the option has intrinsic value before considering the premium paid.
Option premium components
| Component | Meaning | Driver |
|---|---|---|
| Intrinsic value | Immediate exercise value | Moneyness |
| Time value | Extra value from remaining uncertainty | Time to expiry, volatility, rates, dividends, supply/demand |
General relationships:
| If this increases… | Call value usually | Put value usually | Reason |
|---|---|---|---|
| Underlying price | Increases | Decreases | Calls benefit from upside; puts from downside |
| Strike price | Decreases | Increases | Higher strike hurts calls, helps puts |
| Volatility | Increases | Increases | More potential favorable movement |
| Time to expiry | Often increases | Often increases | More time for movement, though details can vary |
| Interest rates | Often increases | Often decreases | Cost-of-carry effect |
| Expected dividends | Often decreases | Often increases | Underlying price may fall on dividend |
The Greeks
| Greek | Measures | High-yield interpretation |
|---|---|---|
| Delta | Sensitivity to underlying price change | Directional exposure |
| Gamma | Sensitivity of delta to underlying price change | Curvature; important near the strike |
| Theta | Sensitivity to time passing | Time decay, usually negative for long options |
| Vega | Sensitivity to volatility | Long options usually benefit from rising volatility |
| Rho | Sensitivity to interest rates | Often less dominant than delta/vega for many questions |
Trap: Vega is not a Greek letter, but it is treated as one of the standard option sensitivities.
Futures and forwards
| Feature | Forward | Future |
|---|---|---|
| Trading | OTC bilateral | Exchange-traded |
| Terms | Customised | Standardised |
| Credit risk | Bilateral counterparty risk | Managed through clearing house and margin |
| Settlement | Usually at maturity, subject to terms | Daily mark-to-market |
| Liquidity | Depends on counterparties | Often higher for standard contracts |
| Flexibility | High | Lower |
Futures margin review:
| Term | Meaning |
|---|---|
| Initial margin | Deposit required to open/maintain position |
| Variation margin | Daily gain/loss settlement from mark-to-market |
| Maintenance margin | Minimum level before margin call may occur |
| Margin call | Requirement to add funds/collateral |
Trap: Futures margin is a performance bond/collateral mechanism, not the same as buying an option premium.
Futures profit/loss often follows:
\[ \text{Futures P\&L} = \text{Price change} \times \text{Contract multiplier} \times \text{Number of contracts} \]If using ticks:
\[ \text{Futures P\&L} = \text{Tick movement} \times \text{Tick value} \times \text{Number of contracts} \]Basis, hedging, and contract choice
Basis is the difference between spot price and futures price, commonly expressed as:
\[ \text{Basis} = \text{Spot price} - \text{Futures price} \]| Hedging issue | Meaning | Exam relevance |
|---|---|---|
| Basis risk | Futures and underlying do not move perfectly together | Hedge may be imperfect |
| Cross hedge | Hedging with a related but different underlying | Correlation matters |
| Contract expiry | Futures maturity may not match exposure date | Roll risk |
| Contract size | Standard contract may not match exposure size | Over- or under-hedging |
| Liquidity | More active contracts may reduce execution cost | Practical hedge selection |
Hedging decision rule:
| Exposure | Price risk | Possible hedge |
|---|---|---|
| Will buy asset later | Price may rise | Long future/forward or long call |
| Will sell asset later | Price may fall | Short future/forward or long put |
| Own asset and fear decline | Downside risk | Long put or short future |
| Owe floating-rate interest | Rates may rise | Interest-rate swap to fixed, or suitable futures/options |
| Receive foreign currency later | FX rate may move adversely | Forward/future/option depending on required flexibility |
Swaps
A swap is an agreement to exchange cash flows according to specified terms.
| Swap type | Typical cash flows | Use |
|---|---|---|
| Interest-rate swap | Fixed rate versus floating rate | Transform interest-rate exposure |
| Currency swap | Cash flows in different currencies | Manage FX and funding exposure |
| Credit default swap | Protection premium versus credit event payment | Transfer credit risk |
| Equity swap | Equity return versus another return | Synthetic equity exposure |
Plain interest-rate swap logic:
- Notional amount is used to calculate payments.
- In many plain interest-rate swaps, notional is not exchanged.
- Netting may mean only the difference between fixed and floating payments is paid.
- Floating leg resets periodically.
- Counterparty credit risk and collateral arrangements matter.
Common trap: A swap can reduce one risk while creating another, such as counterparty, liquidity, operational, or basis risk.
Settlement, clearing, custody, and lifecycle
Trade lifecycle
| Stage | What happens | Key control point |
|---|---|---|
| Order receipt | Client instruction captured | Authority, suitability/appropriateness where relevant, order details |
| Execution | Trade completed on venue or OTC | Best execution, price, venue, time stamping |
| Trade capture | Trade recorded in systems | Correct instrument, quantity, price, counterparty |
| Confirmation | Parties agree economics | Mismatch resolution |
| Clearing | Obligations calculated; CCP may novate | Margin, netting, risk management |
| Settlement instruction | Delivery/payment details sent | Account, custodian, settlement system accuracy |
| Settlement | Securities and cash exchanged | DVP reduces principal risk |
| Custody | Assets safeguarded and recorded | Reconciliation and client asset controls |
| Asset servicing | Income and corporate actions processed | Entitlements, elections, tax documentation |
| Reporting | Client/regulatory/internal reporting | Accuracy, timeliness, recordkeeping |
Notes and examples
Settlement and entitlement terms
| Term | Meaning | Exam cue |
|---|---|---|
| Trade date | Date transaction is executed | Market risk transfers economically from execution |
| Settlement date | Date cash and securities are exchanged | Cash flows and legal title depend on settlement rules |
| DVP | Delivery versus payment | Reduces risk that one side delivers without receiving |
| FOP | Free of payment | Securities move without linked cash payment |
| Failed trade | Settlement does not occur as expected | Can create buy-in, funding, and operational issues |
| Matched trade | Both sides’ settlement instructions agree | Matching is not the same as settlement completion |
| Clearing | Calculation/management of obligations | Occurs before settlement |
| Netting | Offsetting obligations to reduce exposures | Reduces settlement and liquidity needs |
| Novation | CCP becomes buyer to seller and seller to buyer | Reduces bilateral counterparty exposure |
| Custody account | Account holding securities | Legal/beneficial ownership structure matters |
| Nominee | Legal holder on behalf of beneficial owner | Beneficial owner retains economic interest |
| Record date | Date used to determine entitlement | Often confused with ex-date |
| Ex-dividend / ex-date | Buying on/after this date generally excludes dividend entitlement | Price usually adjusts down |
| Cum-dividend | Security trades with dividend entitlement | Buyer typically receives dividend |
| Pay date | Date income is paid | Not the entitlement decision date |
Trade lifecycle
| Stage | Purpose | Candidate check |
|---|---|---|
| Execution | Trade is agreed | Price, quantity, instrument, counterparty |
| Confirmation | Details matched | Prevents disputes |
| Clearing | Obligations calculated and prepared | May involve netting and CCP |
| Settlement | Cash and securities exchanged | Delivery versus payment reduces principal risk |
| Custody | Assets held and serviced | Income, corporate actions, safekeeping |
Important distinction:
- Clearing prepares and manages obligations after trade execution.
- Settlement completes the transfer of cash and securities.
- Custody is ongoing safekeeping and asset servicing after settlement.
CCPs and novation
A central counterparty may step between buyer and seller. Through novation, the CCP becomes buyer to every seller and seller to every buyer.
| Benefit | Explanation |
|---|---|
| Reduced counterparty exposure | Participants face the CCP rather than many bilateral counterparties |
| Netting efficiency | Multiple trades can be netted to reduce settlement obligations |
| Risk management | Margin, default funds, and rules help manage member default |
| Operational standardisation | Common processes for clearing and settlement |
Trap: CCP clearing reduces counterparty risk but does not eliminate all risk. It concentrates risk in the CCP and depends on robust margining and default management.
Corporate actions
| Corporate action | Type | Effect to review |
|---|---|---|
| Cash dividend | Income distribution | Entitlement depends on record/ex-dividend mechanics |
| Stock dividend/scrip | Share-based distribution | More shares, price adjusts economically |
| Rights issue | Capital raising | Existing holders can subscribe, sell rights, or let them lapse depending on terms |
| Bonus issue | Capital restructuring | More shares without new cash from holders |
| Stock split/consolidation | Share count adjustment | Economic value usually unchanged at the moment of action |
| Takeover/merger | Control transaction | May involve cash, shares, or mixed consideration |
| Tender offer | Offer to buy shares | Voluntary decision by holders |
Exam traps:
- Confusing record date with ex-dividend date.
- Treating all corporate actions as cash events.
- Forgetting that voluntary actions require an investor election.
- Assuming a bonus issue creates wealth by itself.
- Ignoring dilution in rights issues and new share issuance.
Risk reference
| Risk | Meaning | Common instruments affected | Mitigation / exam cue |
|---|---|---|---|
| Market risk | Loss from price, rate, spread, FX, or volatility changes | Equities, bonds, derivatives | Diversification, hedging, limits |
| Interest-rate risk | Bond/derivative value changes as rates move | Fixed-rate bonds, swaps, futures | Duration management, swaps, futures |
| Credit risk | Issuer/counterparty fails to pay | Bonds, OTC derivatives, deposits | Credit analysis, collateral, limits |
| Counterparty risk | Trading counterparty defaults before settlement/final maturity | OTC derivatives, repos, securities lending | CCP clearing, collateral, netting, margin |
| Settlement risk | One side delivers but does not receive | Securities, FX, OTC trades | DVP/PVP, settlement controls |
| Liquidity risk | Cannot trade quickly at fair price | Small-cap shares, complex bonds, OTC derivatives | Liquidity limits, wider spread assumption |
| Basis risk | Hedge and exposure do not move together | Futures/forwards hedges | Better matching of asset, tenor, currency |
| Leverage risk | Small market move causes large P/L change | Futures, options, CFDs, margin trades | Margin monitoring, position limits |
| Volatility risk | Option value changes as volatility changes | Options, warrants, structured products | Vega awareness |
| Reinvestment risk | Cash flows reinvested at lower rates | Coupon bonds, callable bonds | Duration/cash-flow matching |
| Inflation risk | Real purchasing power falls | Cash, fixed coupons | Inflation-linked securities, real assets |
| Currency risk | FX movement affects base-currency value | Foreign securities, FX derivatives | FX hedging |
| Operational risk | Failed process, system, or human error | All products | Controls, reconciliations, segregation |
| Legal/documentation risk | Contract terms unenforceable or misunderstood | OTC derivatives, structured products | Standard documents, legal review |
| Model risk | Valuation/hedging model wrong | Complex derivatives, structured notes | Independent validation, stress testing |
| Concentration risk | Exposure too focused | Portfolios, collateral pools | Diversification and exposure limits |
| Tax risk | Tax treatment differs from expectation | Income products, derivatives, cross-border holdings | Jurisdiction-specific advice; do not assume uniform treatment |
Suitability and product-choice cues
Suitability and appropriateness depend on client facts, jurisdiction, and firm rules. For exam scenarios, focus on objective, risk tolerance, time horizon, liquidity need, knowledge/experience, leverage, and capacity for loss.
| Client need or constraint | More likely suitable | Less likely suitable | Reason |
|---|---|---|---|
| Capital preservation, low volatility | Cash, high-quality short-term debt | Uncovered options, leveraged derivatives, speculative shares | Low tolerance for loss |
| Regular income | Bonds, income funds, preference shares, covered call strategy if appropriate | Non-dividend growth stocks, long options alone | Income certainty varies by product |
| Long-term growth | Diversified equities, equity funds, growth shares | Short-dated speculative options as core holding | Equity risk may fit long horizon |
| Hedge existing equity portfolio | Index futures, protective puts, collars | Leveraged long calls as hedge | Hedge should offset existing risk |
| Hedge future purchase price | Long futures/forwards, call options | Short futures | Long hedge protects against price rise |
| Hedge future sale price | Short futures/forwards, put options | Long futures | Short hedge protects against price fall |
| Cannot tolerate margin calls | Fully paid securities, bought options | Futures, short options, leveraged CFDs | Futures/short options can require additional funds |
| Wants capped downside and upside retained | Bought put, protective put strategy | Short futures alone | Put premium buys downside floor |
| Wants to monetize stock position | Covered call, collar | Naked call writing | Covered strategies reduce but do not remove risk |
| Needs liquidity | Major exchange-traded securities | Complex OTC structures | Exit ability is critical |
| Wants defined payoff | Bonds to maturity, structured products with clear terms | Unbounded short option positions | Defined does not mean risk-free; issuer risk remains |
Conduct, regulation, and market integrity vocabulary
| Area | Practical meaning | Exam focus |
|---|---|---|
| Client classification | Different client types receive different protections and disclosures | Do not assume all clients are treated the same |
| KYC / client due diligence | Understand identity, ownership, source of funds, client circumstances | AML and suitability foundations |
| Enhanced due diligence | Higher scrutiny for higher-risk clients/transactions | Risk-based approach |
| Ongoing monitoring | Transactions and client information kept under review | Not a one-time onboarding exercise |
| Suspicious activity escalation | Internal reporting where activity appears suspicious | Follow firm procedures; do not alert client improperly |
| Suitability | Recommendation must fit client objectives, knowledge, risk, and financial position where required | Product risk must match client profile |
| Appropriateness | Assess whether client understands product risk where required | Especially relevant for complex products |
| Disclosure | Provide material product costs, risks, and conflicts | Disclosure alone may not cure unsuitable advice |
| Conflict of interest | Firm/client or client/client interests may conflict | Identify, prevent/manage, disclose where appropriate |
| Best execution | Take sufficient steps to obtain favorable execution outcome | Price is important but not the only factor |
| Market abuse | Misuse of information or behavior damaging market integrity | Insider dealing, unlawful disclosure, manipulation concepts |
| Inside information | Non-public, specific/material information likely to affect price | Possession/use/disclosure issues |
| Market manipulation | False/misleading signals, artificial price, abusive practices | Intent and effect may be tested in scenarios |
| Client assets | Safeguarding and segregation of client money/securities | Reconciliation and custody controls |
| Complaints handling | Fair, timely handling and recordkeeping | Escalation and documentation |
| Personal account dealing | Employee trading controls | Avoid conflicts and misuse of information |
| Recordkeeping | Evidence of orders, advice, communications, decisions | If not recorded, difficult to evidence compliance |
Common exam traps
| Trap | Correct approach |
|---|---|
| Confusing broker and dealer | Broker acts as agent; dealer acts as principal |
| Thinking a dividend is guaranteed | Ordinary dividends depend on declaration and profits/cash policy |
| Treating bonus issue as cash-raising | Bonus issue capitalizes reserves; rights issue raises cash |
| Using clean bond price as settlement cash | Settlement uses dirty price: clean plus accrued interest |
| Forgetting price-yield inverse relationship | Fixed-rate bond price falls when yield rises |
| Assuming all bonds are low risk | Credit, liquidity, duration, subordination, and currency risk matter |
| Mixing up repo perspective | Repo for securities seller/cash borrower; reverse repo for cash lender |
| Treating futures like options | Futures create obligations; options give buyer rights |
| Ignoring margin calls | Futures and short options can require additional funds |
| Saying option buyer can lose unlimited amount | Buyer’s maximum loss is premium; writer’s risk can be large |
| Confusing American and European options | Style is exercise timing, not trading location |
| Assuming OTC means unregulated or risk-free | OTC is customized but still has counterparty, documentation, and conduct risks |
| Ignoring basis risk in hedges | Hedge instrument must match asset, tenor, currency, and sensitivity |
| Assuming CCP removes all risk | CCP reduces bilateral risk but creates margin and clearing dependency |
| Confusing ex-date and record date | Ex-date determines whether new buyer gets entitlement in normal trading |
| Treating disclosure as suitability | A disclosed unsuitable recommendation can still be unsuitable |
| Believing diversification removes all risk | It reduces unsystematic risk, not market/systematic risk |
Rapid scenario decision checklist
Before answering a product or risk question, identify:
- Position direction: long or short; buyer or writer; payer or receiver.
- Instrument type: cash security, debt, equity, derivative, fund, or structured product.
- Cash-flow certainty: contractual, discretionary, variable, or contingent.
- Leverage: fully funded, margin-based, embedded leverage, or premium-only.
- Downside profile: limited to premium, limited to investment, margin-call risk, or potentially unlimited.
- Liquidity: exchange-traded standard instrument or bespoke OTC exposure.
- Counterparty: issuer risk, exchange/CCP clearing, bilateral OTC counterparty, custodian.
- Time horizon: short-term hedge, long-term investment, maturity-matched liability, speculative trade.
- Client objective: income, growth, capital protection, hedging, liquidity, tax planning.
- Conduct overlay: disclosure, suitability, conflicts, market integrity, and recordkeeping.
Big-picture capital markets map
Capital markets questions often test whether you can connect an instrument to its purpose, risk, cash flows, and lifecycle.
| Area | Core idea | Candidate focus |
|---|---|---|
| Equity securities | Ownership interest in an issuer | Rights, dividends, dilution, valuation ratios, market risk |
| Debt securities | Borrowing by an issuer | Coupon, yield, maturity, credit risk, duration, clean/dirty price |
| Money market instruments | Short-term borrowing/investing | Discount instruments, liquidity, low duration, credit quality |
| Derivatives | Contracts whose value is derived from an underlying | Payoff, margin, leverage, hedging, counterparty/clearing risk |
| Trading venues | Where orders meet liquidity | Order-driven vs quote-driven, exchange vs OTC |
| Clearing and settlement | Post-trade completion process | CCPs, novation, delivery versus payment, fails |
| Custody and asset servicing | Safekeeping and administration | Dividends, interest, corporate actions, recordkeeping |
| Risk management | Identifying and controlling exposures | Market, credit, liquidity, operational, legal, model risk |
Notes and examples
A useful mental sequence:
Instrument → parties → cash flows → price drivers → risk → trading/settlement → exam trap
If you cannot explain all six for an instrument, it is a good target for topic drills.
Securities: high-yield review
Equity securities
Equity represents ownership. Ordinary shareholders usually rank behind creditors if the company is wound up, but they participate in upside through capital growth and dividends.
| Concept | Review point | Common trap |
|---|---|---|
| Ordinary shares | Voting rights, residual claim, variable dividends | Dividends are not guaranteed |
| Preference shares | Often fixed dividend priority over ordinary shares | Not the same as debt; terms vary |
| Market capitalisation | Share price × number of shares | Do not confuse share price with company size |
| Dividend yield | Annual dividend / share price | A high yield can reflect falling price or risk |
| Earnings per share | Profit attributable to ordinary shareholders / shares | Dilution affects per-share metrics |
| Price/earnings ratio | Share price / EPS | A high P/E may indicate growth expectations or overvaluation |
| Rights issue | Existing holders offered new shares, usually at a discount | Ignoring dilution and renounceable rights |
| Bonus/scrip issue | Additional shares issued, often from reserves | Value per shareholder does not automatically increase |
| Stock split | More shares at lower price per share | Economic ownership is usually unchanged |
Notes and examples
Key exam logic:
- Equity investors accept higher uncertainty for potential growth.
- Ordinary shareholders are last in liquidation after secured creditors, unsecured creditors, and preference shareholders.
- Corporate actions can change the number of shares, price per share, voting position, or cash received.
- Ex-dividend means the buyer is not entitled to the declared dividend; the price may adjust downward.
Debt securities
Debt securities create a creditor relationship. The issuer borrows; investors lend. The investor expects interest and principal repayment according to the instrument terms.
| Feature | Meaning | Why it matters |
|---|---|---|
| Nominal/par value | Amount on which coupon is usually calculated | Not always equal to market price |
| Coupon | Stated interest rate or amount | Coupon is not the same as yield |
| Maturity | Date principal is due | Longer maturity often means more interest-rate sensitivity |
| Yield | Return implied by price and cash flows | Price and yield move inversely |
| Credit spread | Extra yield over lower-risk benchmark | Reflects credit/liquidity risk |
| Seniority | Ranking in issuer default | Affects recovery expectation |
| Secured debt | Backed by specific assets/collateral | Usually lower credit risk than comparable unsecured debt |
| Callable bond | Issuer can redeem early | Reinvestment risk for investor |
| Convertible bond | Can convert into equity under terms | Hybrid debt/equity behavior |
| Floating-rate note | Coupon resets to reference rate plus/minus margin | Lower duration than comparable fixed-rate debt |
Bond price and yield relationships
The most tested bond relationship is simple:
| If market interest rates… | Existing fixed-coupon bond price usually… | Reason |
|---|---|---|
| Rise | Falls | Existing coupon becomes less attractive |
| Fall | Rises | Existing coupon becomes more attractive |
Additional decision rules:
- Higher coupon, all else equal, generally reduces duration compared with a lower-coupon bond of the same maturity.
- Longer maturity generally increases interest-rate sensitivity.
- Higher credit risk usually requires higher yield.
- Yield to maturity assumes cash flows are received as scheduled and incorporates price, coupon, and redemption value.
Common calculation distinctions:
| Calculation | Plain-language formula | Trap |
|---|---|---|
| Current yield | Annual coupon / market price | Ignores capital gain/loss to redemption |
| Clean price | Quoted bond price excluding accrued interest | Not the cash settlement amount |
| Dirty price | Clean price + accrued interest | Buyer pays accrued interest to seller |
| Accrued interest | Coupon for period × elapsed days / days in coupon period | Day-count basis matters if specified |
| Capital gain/loss | Sale/redemption price − purchase price | Separate from coupon income |
Money market instruments
Money market securities are short-term instruments used for liquidity management, funding, and cash investment.
| Instrument | Typical user/purpose | Review point |
|---|---|---|
| Treasury bills | Government short-term funding | Often issued at discount and redeemed at face value |
| Commercial paper | Corporate short-term funding | Unsecured; credit quality matters |
| Certificates of deposit | Bank funding/investor cash management | Negotiable term deposit instrument |
| Repos | Secured short-term borrowing/lending | Securities sold with agreement to repurchase |
| Bills of exchange/acceptances | Trade finance and short-term credit | Understand parties and credit support |
Repo logic is commonly tested:
- The cash lender receives securities as collateral.
- The cash borrower provides securities and agrees to repurchase them.
- The difference between sale and repurchase price reflects the repo rate.
- Collateral quality, haircuts, and operational settlement are important risk controls.
Securities markets and trading
Primary versus secondary markets
| Market | Main function | Example |
|---|---|---|
| Primary market | Issuer raises new capital | IPO, bond issue, rights issue |
| Secondary market | Existing securities trade between investors | Exchange or OTC trading after issuance |
Notes and examples
Primary market questions often ask who receives proceeds. If new securities are issued, proceeds usually go to the issuer, after costs. In secondary trading, proceeds go to the selling investor, not the issuer.
Order-driven and quote-driven trading
| Model | How prices form | Typical exam angle |
|---|---|---|
| Order-driven | Buy and sell orders interact in an order book | Priority, limit orders, market orders |
| Quote-driven | Market makers quote bid and offer prices | Spread, dealer inventory risk |
| Hybrid | Combines order book and dealer liquidity | Know both mechanisms |
Order type review:
| Order type | Meaning | Trap |
|---|---|---|
| Market order | Execute immediately at best available price | Price uncertainty in volatile/illiquid markets |
| Limit order | Execute only at specified price or better | May not execute |
| Stop order | Triggered when price reaches a level | Trigger price is not guaranteed execution price |
| Fill-or-kill/immediate-or-cancel | Execution condition attached | Do not assume partial fill unless terms allow |
Bid/offer rule:
- Bid = price at which dealer/market is willing to buy from you.
- Offer/ask = price at which dealer/market is willing to sell to you.
- Investor buying usually pays the offer.
- Investor selling usually receives the bid.
- Spread compensates liquidity provision, risk, and costs.
Short selling and securities lending
Short selling involves selling securities not currently owned, usually by borrowing them first.
| Step | What happens |
|---|---|
| Borrow stock | Short seller borrows securities from lender |
| Sell stock | Short seller sells into market |
| Repurchase later | Short seller buys back securities |
| Return stock | Borrowed securities are returned to lender |
Profit/loss logic:
- Short seller benefits if price falls.
- Short seller loses if price rises.
- Potential loss is theoretically large because price can rise significantly.
- Borrowing costs, recalls, dividends, and corporate actions can affect economics.
Risk review across securities and derivatives
Main risk types
| Risk | Meaning | Example |
|---|---|---|
| Market risk | Loss from price, rate, spread, FX, or volatility movement | Bond price falls when yields rise |
| Credit risk | Counterparty/issuer fails to pay | Corporate bond default |
| Liquidity risk | Cannot trade without major price impact | Wide spread in stressed market |
| Settlement risk | One party delivers but does not receive | Failure in payment/security exchange |
| Counterparty risk | Trading counterparty defaults before settlement/maturity | OTC derivative exposure |
| Operational risk | Process, people, systems, or external event failure | Incorrect settlement instruction |
| Legal/documentation risk | Contract unenforceability or unclear terms | Dispute over derivative close-out |
| Model risk | Incorrect valuation/risk model assumptions | Mispriced option volatility |
| Leverage risk | Small market move causes amplified P&L | Futures or options exposure |
| Reinvestment risk | Future cash flows reinvested at lower rates | Callable bond redeemed early |
| Inflation risk | Real value eroded | Fixed coupon loses purchasing power |
Notes and examples
Risk controls
| Control | Purpose |
|---|---|
| Diversification | Reduces concentration risk, not systemic risk |
| Limits | Caps exposure by issuer, sector, product, counterparty, or trader |
| Margin/collateral | Reduces unsecured exposure |
| Netting | Reduces gross obligations to smaller net exposure |
| Stress testing | Assesses impact of extreme but plausible events |
| Independent valuation | Reduces pricing/model bias |
| Reconciliation | Detects booking, cash, and position breaks |
| Segregation of duties | Reduces fraud and error risk |
| Documentation | Clarifies rights, obligations, close-out, collateral, and events of default |
Decision rules for fast exam questions
Instrument selection
| Need | More likely instrument |
|---|---|
| Raise permanent capital without mandatory interest | Ordinary shares |
| Raise capital with contractual interest and maturity | Bond/debt security |
| Short-term funding | Money market instrument, repo, commercial paper, bank funding |
| Protect portfolio from market fall while retaining upside | Put option |
| Gain leveraged upside with limited loss | Call option |
| Lock in future purchase/sale price | Forward or future |
| Custom maturity/notional/underlying | OTC forward or swap |
| Standardised, exchange-traded exposure | Future or exchange-traded option |
| Convert floating-rate liability to fixed | Pay-fixed interest-rate swap |
| Borrow cash against securities collateral | Repo |
| Receive income from option premium but accept obligation | Short option strategy |
Notes and examples
Price and risk direction
| Situation | Likely effect |
|---|---|
| Interest rates rise | Fixed bond prices fall |
| Credit spread widens | Corporate bond price falls |
| Equity volatility rises | Long option values usually rise |
| Underlying rises | Calls gain value; puts lose value |
| Time passes | Long options usually lose time value |
| Liquidity deteriorates | Spreads widen; execution risk rises |
| Issuer credit worsens | Debt yield rises; price falls |
| Dividend expectation rises | Calls may be less valuable; puts may be more valuable |
Lifecycle distinction questions
| If the question mentions… | Think… |
|---|---|
| New securities sold by issuer | Primary market |
| Existing investor sells to another investor | Secondary market |
| Trade details matched | Confirmation/matching |
| Netting and CCP | Clearing |
| Cash and securities exchanged | Settlement |
| Holding assets and collecting income | Custody |
| Entitlement to dividend/rights | Corporate action processing |
| Daily gain/loss on futures | Variation margin |
| Collateral for OTC exposure | Counterparty risk mitigation |
Common traps and candidate mistakes
Securities traps
- Confusing coupon with yield.
- Forgetting that bond prices and yields move in opposite directions.
- Treating clean price as the final cash settlement amount.
- Assuming all preference shares are identical.
- Ignoring seniority and security when comparing debt instruments.
- Thinking a stock split automatically creates shareholder wealth.
- Forgetting dilution in rights issues, convertibles, and new share issues.
- Confusing primary market proceeds with secondary market proceeds.
- Misreading bid and offer from the investor’s perspective.
- Assuming liquidity risk only applies to small companies; stressed markets can affect many instruments.
Notes and examples
Derivatives traps
- Forgetting that option buyers have rights and option sellers have obligations.
- Ignoring the premium when calculating option profit or breakeven.
- Treating futures margin as the cost of buying the contract.
- Confusing a forward with a future.
- Forgetting daily mark-to-market on futures.
- Assuming a hedge eliminates all risk.
- Mixing up long hedge and short hedge.
- Using notional value as if it were the amount at risk in every derivative.
- Confusing intrinsic value with total option premium.
- Forgetting that a short call has potentially very large loss exposure.
- Assuming OTC customisation always means lower risk; it can increase counterparty and liquidity risk.
Wording traps
Watch for these phrases:
| Phrase | Why it matters |
|---|---|
| “Best describes” | More than one answer may sound partly right |
| “Most likely” | Choose the standard market principle unless facts override it |
| “Except” | You are looking for the false statement |
| “All else equal” | Isolate one variable only |
| “At expiry” | Ignore remaining time value for option payoff |
| “Before premium” | Calculate payoff, not profit |
| “After premium” | Include option cost/income |
| “Clean price” | Excludes accrued interest |
| “Dirty price” | Includes accrued interest |
| “Hedge” | Risk reduction, not guaranteed profit |
Calculation checklist
Before doing any calculation, identify:
- What is being asked: price, yield, payoff, profit, margin movement, ratio, or settlement amount?
- Whether the question is from the buyer’s or seller’s perspective.
- Whether cash flows are income, capital gain/loss, premium, margin, or accrued interest.
- Whether figures are per share, per bond, per contract, or total position.
- Whether the answer should include or exclude premium, accrued interest, or transaction costs if specified.
Quick formula reminders:
| Topic | Formula in plain text |
|---|---|
| Market capitalisation | Share price × number of shares |
| Dividend yield | Annual dividend per share / share price |
| Earnings per share | Earnings attributable to ordinary shareholders / ordinary shares |
| P/E ratio | Share price / earnings per share |
| Bond current yield | Annual coupon / market price |
| Dirty price | Clean price + accrued interest |
| Call payoff at expiry | Maximum of underlying price − strike, or zero |
| Put payoff at expiry | Maximum of strike − underlying price, or zero |
| Long call breakeven | Strike + premium |
| Long put breakeven | Strike − premium |
| Futures P&L | Price movement × multiplier × contracts |
| Tick P&L | Tick movement × tick value × contracts |
Notes and examples
Final quick checklist
Before moving to your next question-bank session, confirm you can answer these without notes:
- What is the difference between ordinary shares, preference shares, and debt?
- Why do bond prices usually fall when yields rise?
- What is the difference between clean and dirty bond price?
- Who receives proceeds in a primary issue versus a secondary trade?
- What is the difference between execution, clearing, settlement, and custody?
- What does a CCP do, and what does novation mean?
- How do rights issues, bonus issues, splits, and dividends affect holders?
- What is the difference between a forward and a future?
- Why is futures margin not an option premium?
- What is the payoff of a long call, long put, short call, and short put?
- How do you calculate option breakeven after premium?
- What is basis risk?
- What risks remain after a hedge is placed?
- Which risk control best addresses counterparty, liquidity, operational, or market risk?
Practice plan with independent companion questions
Use this Cheat Sheet as a checkpoint, then move into structured question-bank practice. The fastest improvement usually comes from topic drills followed by careful review of detailed explanations, not from repeatedly taking full mocks without analysis.
Suggested drill sequence
| Stage | Practice focus | What to learn from explanations |
|---|---|---|
| 1 | Securities definitions | Instrument features, ranking, cash flows |
| 2 | Bond and equity calculations | Formula selection and investor perspective |
| 3 | Trading and settlement | Lifecycle sequencing and terminology |
| 4 | Corporate actions | Entitlements, dilution, voluntary vs mandatory actions |
| 5 | Derivative payoffs | Long/short, right/obligation, premium treatment |
| 6 | Futures, forwards, swaps | Margin, standardisation, counterparty risk |
| 7 | Risk management | Matching risk type to control |
| 8 | Mixed mock sets | Speed, wording discipline, weak-topic detection |
Notes and examples
Error log categories
When you miss an original practice question, classify the miss:
| Error type | Example | Fix |
|---|---|---|
| Definition gap | Could not distinguish clearing from settlement | Re-read lifecycle table and drill terminology |
| Direction error | Chose bond price rises when yields rise | Memorise inverse price/yield rule |
| Long/short confusion | Treated short call like long call | Redraw payoff direction |
| Premium omission | Calculated option payoff but not profit | Mark whether question asks payoff or profit |
| Perspective error | Used bid when investor was buying | Apply investor pays offer, receives bid |
| Calculation setup | Used per-contract value instead of total contracts | Write units before calculating |
| Overthinking | Ignored “all else equal” | Isolate the tested variable |
| Wording miss | Missed “except” | Underline negative wording in practice |
How to use mocks efficiently
- Do not begin with only full mocks if core concepts are weak.
- Use topic drills to build accuracy first.
- Use timed mixed sets to test switching between securities and derivatives.
- Review every answer explanation, including correct guesses.
- Re-attempt missed questions after a delay.
- Track recurring mistakes by topic, not just overall score.
- Use full mock exams late in preparation to practise pacing and endurance.