2-Financial Markets Page 73 Wednesday, February 4, 2004 1:15 PM
Overview of Financial Markets, Financial Assets, and Market Participants 73■ An option is a contract in which the writer of the option grants the
buyer of the option the right, but not the obligation, to purchase from
the writer (a call option) or sell to the writer (a put option) the underly-
ing at the strike (or exercise) price within a specified period of time (or
at a specified date); the option price is a reflection of the option’s intrin-
sic value and any additional amount over its intrinsic value.
■ A swap is an agreement whereby the counterparties agree to exchange
periodic payments; the dollar amount of the payments exchanged is
based on a notional amount.
■ A cap and a floor are agreements whereby one party, for a fee (pre-
mium), agrees to compensate the other if a designated reference is dif-
ferent from a predetermined level.