📘 FIN310 — Final Exam Study Guide (Part III: Markets & Trading)

Why investors hold gold/commodities

• Potential inflation hedge and crisis hedge (but not perfect and not every year).
• Source of diversification relative to stocks and bonds.
• Commodities are real assets; prices driven by supply/demand, storage costs, and global conditions.

Ways to get gold exposure

• Physical gold (coins/bars/jewelry): storage, liquidity, and transaction costs matter.
• Gold ETFs (for example GLD, IAU, GLDM): easy to trade, no personal storage. Key differences:
  • Expense ratio (annual fee).
  • Share price and tick size.
  • Liquidity and bid–ask spread.
• Gold futures (COMEX contracts): large, leveraged exposure. Contract size (for example 100 oz vs 10 oz mini) magnifies P/L.

COMEX gold futures basics

• Standard GC contract ≈ 100 oz; mini MGC ≈ 10 oz.
• Dollar exposure = futures price × contract size.
• Daily P/L ≈ (new price − old price) × contract size × number of contracts.

Drivers of gold prices

• Real interest rates and the opportunity cost of holding gold (no coupons/dividends).
• U.S. dollar strength/weakness (gold usually quoted in USD).
• Inflation expectations, geopolitical risk, and central bank purchases.

Checklist — can you…?

• Explain pros/cons of physical gold vs ETF vs futures for a typical investor?
• Compute the dollar exposure of one gold futures contract and the P/L for a small price move?
• Give an intuitive story for why gold might fall when real yields rise?

Contract language & mechanics

• A futures contract specifies: underlying, contract size, delivery month, price quotation, and trading venue.
• Going long futures: agree to buy later; gain when price goes up.
• Going short futures: agree to sell later; gain when price goes down.
• Futures are marked-to-market daily; gains/losses flow through margin accounts.

Margin and daily P/L

• Initial margin: amount you post to open a position.
• Maintenance margin: if account value falls below this, you get a margin call.
• Daily P/L ≈ (F_new − F_old) × contract size × number of contracts.

Basis & convergence

• Basis = spot price − futures price.
• As maturity approaches, futures price tends to converge to spot (ignoring frictions).
• Contango vs backwardation: storage, financing and “convenience yield” can make futures above or below spot.

Hedging logic (direction & size)

• General rule:
  • If you are economically long the asset (benefit if price rises), you hedge by shorting futures.
  • If you are economically short the asset (benefit if price falls), you hedge by going long futures.
• Simple hedge size idea: number of contracts ≈ exposure ÷ (futures price × contract size).

Case examples

• Airline with future jet fuel needs → short fuel futures to lock in price range.
• Jeweler holding gold inventory → short gold futures to protect against price drops.
• Exporter expecting foreign-currency revenue → use currency futures to lock in home-currency value.

Checklist — can you…?

• Given a story, decide whether the hedge should be long or short futures?
• Compute approximate number of contracts needed for a simple hedge?
• Explain in words how daily margining changes cash flows for a hedger?

Mutual fund basics

• Open-end mutual funds: investors buy/sell at end-of-day NAV.
• Share classes: A (front load), B/C (deferred or level loads), institutional/no-load classes.
• ETFs vs mutual funds: intraday trading vs end-of-day NAV; usually lower expense ratios for broad index ETFs.

Fees & performance drag

• Expense ratio: annual % fee taken from assets; reduces return every year.
• Loads (front-end/back-end) are one-time transaction costs on top.
• Even small fee differences compound and create large performance gaps over time.

Active vs passive & “what are you actually buying?”

• Passive/index funds: track a benchmark (for example S&P 500); goal is low tracking error.
• Active funds: try to beat a benchmark via security selection, timing, factor tilts, etc.
• Sector/factor funds (value, growth, small-cap, dividend, etc.) can concentrate risk.

Reading a basic fund profile

• Look at: objective, benchmark, fees, past performance, volatility, top holdings, style box.
• Check for overlap with funds you already own (duplicated holdings).
• Watch for style drift: a “value” fund that slowly becomes more growth-like, etc.

Checklist — can you…?

• Explain when a low-cost index fund is likely “good enough”?
• Compare two funds with different fees and benchmarks and pick one for a scenario?
• List several common mistakes (chasing last year’s winner, ignoring fees, overconcentrating sectors)?

Basic FX language

• Nominal exchange rate: price of one currency in terms of another (for example USD per EUR).
• “Dollar strengthening” vs “weakening”: how many foreign units a dollar can buy.
• Real exchange rate: adjusts for relative price levels (inflation) — we stay intuitive in this course.

Core drivers of exchange rates

• Relative interest rates (central bank policy, real yields).
• Relative inflation and growth prospects.
• Risk sentiment and “safe haven” flows (risk-on vs risk-off).
• Capital flows, trade balances, and policy announcements.

Parity intuition & politics

• Interest-rate differences and expected currency moves are linked in theory (interest rate parity).
• In practice, high-yield currencies can either appreciate (carry trade works) or crash if risk sentiment turns.
• Why some leaders prefer a weaker currency: supports exporters, tourism, and can raise inflation.

Impacts of a strong vs weak USD

• Strong USD: cheaper imports for U.S. consumers; harder for U.S. exporters; more stress for some EMs that borrow in USD.
• Weak USD: opposite effects; often supports global commodity prices (quoted in USD).

Checklist — can you…?

• Given a news story about Fed policy vs ECB/BoJ, predict qualitative direction of the USD?
• Explain how higher U.S. rates might impact EM countries that borrow in dollars?
• Tell a short story why a president might want a weaker currency in the short run?

Calls, puts, and basic payoffs

• Call option: right (not obligation) to buy at strike K before/at maturity.
• Put option: right (not obligation) to sell at strike K.
• Long option position: you pay premium; risk limited to premium; upside is asymmetric.
• Short option position: you receive premium; potentially large downside; used cautiously.

Intrinsic vs time value; ITM/ATM/OTM

• Intrinsic value = immediate exercise value (never negative).
• Time value = extra value from volatility and time until expiration.
• ITM, ATM, OTM describe where strike K is relative to spot price.

Hedging structures

• Protective put: long stock + long put → limits downside while keeping most upside.
• Covered call: long stock + short call → income from premium, but upside is capped above strike.
• Zero-cost collar: long stock + long put + short call (premiums roughly offset) → outcomes constrained in a band.

Volatility intuition

• Options are like insurance; higher expected volatility → more expensive premiums.
• Implied volatility (from option prices) vs realized volatility (what actually happens).

Checklist — can you…?

• Given a scenario (“I own stock and fear a big drop”), pick a reasonable option hedge?
• Sketch or describe the payoff shape of a protective put vs covered call?
• Explain in words why options get more expensive when market fear/uncertainty rises?

From mortgage to bond

• Individual mortgages are pooled into a trust; investors buy claims on the pool’s cash flows.
• Pass-through structure: principal and interest are passed through (minus servicing/guarantee fees).

Agency vs non-agency

• Agency MBS: issued/guaranteed by Ginnie Mae, Fannie Mae, Freddie Mac; very low credit risk on principal/interest.
• Non-agency/private-label MBS: no government guarantee; more credit risk; rely on structure and collateral quality.

Prepayment & negative convexity

• Borrowers can prepay or refinance. Prepayments speed up when rates fall and slow when rates rise.
• When rates fall, investors get principal back sooner and must reinvest at lower yields.
• When rates rise, principal comes back slower; effective duration gets longer — negative convexity.

MBS and 2008 (high level)

• Subprime mortgages, weak underwriting, and overreliance on models/ratings.
• Tranching created many AAA slices backed by risky loans.
• When house prices fell and defaults rose, structures did not protect investors as expected.

Checklist — can you…?

• Explain why prepayment is a risk (not always “good news”) for MBS investors?
• Describe what “negative convexity” means in plain language for a mortgage investor?
• State one key difference between agency and non-agency MBS?

General ABS structure

• Pool of loans (credit cards, student loans, auto loans, etc.) is transferred to a special-purpose vehicle (SPV).
• SPV issues tranches: AAA senior, mezzanine, and equity (“first-loss”) pieces.
• Cash flows follow a waterfall: senior tranches paid first, equity last.

Collateral types & features

• Credit card ABS: revolving pools, shorter average life, sensitive to consumer credit and unemployment.
• Auto loan ABS: amortizing loans; collateral is the vehicle; sensitive to used car values and borrower behavior.
• Student loan ABS (SLABS): long maturities; exposed to forbearance, income-based repayment, and policy risk.

Credit enhancement & risk

• Overcollateralization, subordination, reserve accounts, and excess spread protect senior tranches.
• Investors care about default rates, recovery rates, prepayment speeds, and servicer quality.

ABS vs MBS (big picture)

• Similar: pooling, tranching, and waterfall structures.
• Different: underlying collateral and behavior (prepayment patterns, default dynamics).

Checklist — can you…?

• Explain who takes losses first in a typical ABS structure and who is protected the most?
• Compare risk themes for credit card ABS vs auto ABS vs SLABS?
• Describe why an investor might still buy AAA ABS even though the underlying loans are risky?

Core money market instruments

• T-bills: short-term U.S. government debt; very low credit risk; sold at a discount.
• Commercial paper: short-term unsecured borrowing by corporations or financial institutions.
• Certificates of deposit (CDs): time deposits issued by banks.
• Money market funds: pooled vehicles investing in short-term instruments.

Repo basics

• Repurchase agreement (repo): effectively a secured overnight loan using securities as collateral.
• Structure: “sell” a security today and “agree to repurchase” it later at a slightly higher price (the repo rate).
• General collateral (GC) vs specials: GC can be many acceptable securities; “special” repos are for in-demand bonds.
• Haircut: difference between collateral market value and cash lent; protects the lender.

Why money markets matter

• Short-term funding lifeblood for banks, dealers, and corporates.
• Stress often shows up as spikes in money market rates or difficulty rolling funding.
• Central bank facilities (for example ON RRP) help provide a floor/backstop for short-term rates.

Checklist — can you…?

• Given a simple scenario, choose between T-bills, commercial paper, or a money market fund for short-term cash?
• Describe a basic repo transaction in plain English (who lends what to whom, and what they get back)?
• Explain why loss of confidence in money markets can create system-wide stress?

Practical exam strategies

• The final exam portion for Part III uses 80 True/False questions covering Sessions 10–17 (commodities & gold, futures & hedging, mutual funds, FX, options, MBS, ABS, money markets & repo).
• Out of the 80 T/F items, 5 questions are not graded. That means only 75 questions count toward your Part III score, but you should still answer all of them.
• Questions are designed to test fundamental understanding, not memorization: know what each instrument is, who uses it, and what main risk(s) the holder faces.
• Expect “direction” questions such as:
  • If X (price, yield, FX rate, or volatility) goes up, who gains and who loses?
  • If you want to reduce exposure to X, which side of which contract do you take?
• Do not over-memorize formulas. Focus on signs (gain vs loss), comparative size, and qualitative relationships (for example higher rates → what happens to bond prices, MBS prepayments, FX, etc.).