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Subject 4. Contingent Claims PDF Download
A contingent claim is a derivative contract with a payoff dependent on the occurrence of a future event. It can be either exchange-traded or over-the-counter.

  • The primary types of contingent claims are options. The payoff of an option is contingent on the occurrence of an event.

    In essence, options represent the right, not commitment, to buy or sell. They are created only by selling and buying. For every owner (buyer, option holder) of an option (who has all the rights), there is a seller (option writer) who has all the obligations. The seller receives payment (the premium) for an option from the buyer, and confers rights to the option buyer.

  • Other types of contingent claims involve variation of options, often combined with other financial instruments or derivatives.

    • Many corporations issue convertible bonds, which are bonds that can be exchanged for the stock of the issuing firm at a pre-agreed time and exchange ratio. The bondholder has an option to participate in gains on the market price of the firm's stock without having to participate in losses on the stock.

    • Callable bonds are redeemable by the issuer before the maturity under specific conditions and at a stated price. The issuer has an option to pay off the bonds before maturity.

    • Warrants are securities entitling the holder to buy a proportionate amount of stocks at some specified future date at a specified price. They are similar to call options.

    • Exotic options are options that are more complex than basic put or call options. Exotic options trade over-the-counter.

    • Interest rate options are options whose underlying asset is an interest rate.

    • Options on futures are options whose underlying asset is a futures contract. They are all exchange-traded.

    • Asset-backed securities are securities that are collateralized by a pool of securities such as mortgages, loans or bonds. Typically borrowers of mortgages, loans or bonds have the prepayment option to pay off their debts early.

Learning Outcome Statements

b. contrast forward commitments with contingent claims;

c. define forward contracts, futures contracts, options (calls and puts), swaps, and credit derivatives and compare their basic characteristics;

CFA® 2020 Level I Curriculum, 2020, Volume 6, Reading 48

User Contributed Comments 4

User Comment
BunnyBaby Types of Contingent Claims
Derivative based (contingent) on the a future event taking place. (if the event takes place then {})

Most common types of contingent claims are options contracts and variations thereof

Seller= receives premium in exchange for obligations
Buyer= receives options to exercise rights by giving the premium

Popular variations of options:

Convertible bonds- can be exchanged for stock in the firm at a pre-agreed time and exchange ratio.

Callable bonds- redeemable before the maturity at a stated price, issuer can pay off bonds prior to maturity

Warrants- holder may buy a proportionate amount of stock at x time and at x price

Exotic= OTC and complex

Interest rate options- underlying asset is an interest rate

Options on futures- underlying asset is a futures contract

Asset-backed securities- collateralized by a pool of securities mrtgages, loans or bonds, borrowers of the loans have prepayment option
mpapwa22 Wow...Bunnybaby...nice summary of summary....cool
johntan1979 Yeah, probably you can start your own site too, called BunnyNotes
Shaan23 What a waste of 10 minutes typing that out...i feel younger now.
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I passed! I did not get a chance to tell you before the exam - but your site was excellent. I will definitely take it next year for Level II.
Tamara Schultz

Tamara Schultz

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