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Derivatives

Author Niall O'Sullivan , Dirk Nitzsche , Keith Cuthbertson
Release Date: 2019/12/01
ISBN: 9781119595595
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Book Description

Three experts provide an authoritative guide to the theory and practice of derivatives

Derivatives: Theory and Practice and its companion website explore the practical uses of derivatives and offer a guide to the key results on pricing, hedging and speculation using derivative securities. The book links the theoretical and practical aspects of derivatives in one volume whilst keeping mathematics and statistics to a minimum. Throughout the book, the authors put the focus on explanations and applications.

Designed as an engaging resource, the book contains commentaries that make serious points in a lighthearted manner. The authors examine the real world of derivatives finance and include discussions on a wide range of topics such as the use of derivatives by hedge funds and the application of strip and stack hedges by corporates, while providing an analysis of how risky the stock market can be for long-term investors, and more.

To enhance learning, each chapter contains learning objectives, worked examples, details of relevant finance blogs technical appendices and exercises.

Table of Contents

  1. Cover
  2. About the Authors
  3. About the Companion Site
  4. Preface
    1. STUDENT LEARNING
    2. FINANCE BLOGS
    3. SLIDES
    4. EXERCISES
    5. EXCEL AND MATLAB
    6. ACKNOWLEDGEMENTS
  5. CHAPTER 1: Derivative Securities
    1. 1.1. FORWARDS AND FUTURES
    2. 1.2. OPTIONS
    3. 1.3. SWAPS
    4. 1.4. HEDGING, SPECULATION, AND ARBITRAGE
    5. 1.5. SHORT-SELLING
    6. 1.6. SUMMARY
    7. EXERCISES
    8. NOTES
  6. PART I: FORWARDS AND FUTURES
    1. CHAPTER 2: Futures Markets
      1. 2.1 TRADING ON FUTURES MARKETS
      2. 2.2 FUTURES EXCHANGES AND TRADERS
      3. 2.3 MARGINS AND MARKING-TO-MARKET
      4. 2.4 SUMMARY
      5. EXERCISES
      6. NOTES
    2. CHAPTER 3: Forward and Futures Prices
      1. 3.1 PRICING FORWARD CONTRACTS
      2. 3.2 DIVIDENDS, STORAGE COSTS, AND CONVENIENCE YIELD
      3. 3.3 COMMODITY FUTURES
      4. 3.4 VALUE OF A FORWARD CONTRACT
      5. 3.5 SUMMARY
      6. EXERCISES
      7. NOTES
    3. CHAPTER 4: Futures: Hedging and Speculation
      1. 4.1 HEDGING USING FUTURES
      2. 4.2 NOVEL FUTURES CONTRACTS
      3. 4.3 SPECULATION
      4. 4.4 SUMMARY
      5. EXERCISES
      6. NOTES
    4. CHAPTER 5: Index Futures
      1. 5.1 STOCK INDEX FUTURES (SIF)
      2. 5.2 INDEX ARBITRAGE
      3. 5.3 HEDGING
      4. 5.4 TAILING THE HEDGE
      5. 5.5 SUMMARY
      6. APPENDIX 5: HEDGE RATIOS
      7. EXERCISES
      8. NOTES
    5. CHAPTER 6: Strategies: Stock Index Futures
      1. 6.1 UNDERPRICED STOCKS: HEDGING MARKET RISK
      2. 6.2 OVERPRICED STOCKS: HEDGING MARKET RISK
      3. 6.3 MARKET-NEUTRAL HEDGE FUND
      4. 6.4 LONG-SHORT HEDGE FUND
      5. 6.5 CHANGING STOCK MARKET EXPOSURE
      6. 6.6 MERGER ARBITRAGE
      7. 6.7 SUMMARY
      8. APPENDIX 6.A: STOCK PICKING AND MARKET RISK
      9. APPENDIX 6.B: MARKET TIMING
      10. APPENDIX 6.C: HEDGING: LONG-SHORT PORTFOLIO
      11. APPENDIX 6.D: MERGER ARBITRAGE AND HEDGING
      12. EXERCISES
      13. NOTES
    6. CHAPTER 7: Currency Forwards and Futures
      1. 7.1 FX-FUTURES CONTRACTS
      2. 7.2 PRICING FX-FORWARD CONTRACTS
      3. 7.3 PRICING FX-FUTURES CONTRACTS
      4. 7.4 HEDGING AND SPECULATION: FORWARDS
      5. 7.5 HEDGING AND SPECULATION: FUTURES
      6. 7.6 SUMMARY
      7. APPENDIX 7: HEDGING USING FX-FUTURES
      8. EXERCISES
      9. NOTE
  7. PART II: FIXED INCOME: CASH MARKETS
    1. CHAPTER 8: Interest Rates
      1. 8.1 LIBOR, REPOS, FED FUNDS, AND OIS RATES
      2. 8.2 DAY-COUNT CONVENTIONS
      3. 8.3 FORWARD RATES
      4. 8.4 FORWARD RATE AGREEMENTS (FRAS)
      5. SUMMARY
      6. EXERCISES
      7. NOTES
    2. CHAPTER 9: Bond Markets
      1. 9.1 PRICES, YIELDS, AND RETURN
      2. 9.2 PRICING COUPON BONDS
      3. 9.3 SUMMARY
      4. EXERCISES
      5. NOTE
    3. CHAPTER 10: Bonds: Duration and Convexity
      1. 10.1 YIELD CURVE
      2. 10.2 DURATION AND CONVEXITY
      3. 10.3 SUMMARY
      4. APPENDIX 10: DURATION AND CONVEXITY
      5. EXERCISES
      6. NOTE
  8. PART III: FIXED INCOME FUTURES CONTRACTS
    1. CHAPTER 11: Interest Rate Futures
      1. 11.1 THREE-MONTH EURODOLLAR FUTURES CONTRACT
      2. 11.2 STERLING 3-MONTH FUTURES CONTRACT
      3. 11.3 T-BILL FUTURES
      4. 11.4 FUTURES PRICE AND FORWARD RATES
      5. 11.5 PRICING INTEREST RATE FUTURES
      6. 11.6 ARBITRAGE: IMPLIED REPO RATE
      7. 11.7 SPECULATION
      8. 11.8 SPREAD TRADES
      9. 11.9 SUMMARY
      10. APPENDIX 11.A: FUTURES PRICES AND INTEREST RATES
      11. EXERCISES
      12. NOTES
    2. CHAPTER 12: Hedging with Interest Rate Futures
      1. 12.1 NUMBER OF FUTURES CONTRACTS
      2. 12.2 DIFFERENT TYPES OF HEDGE
      3. 12.3 HEDGING: T-BILL AND EURODOLLAR FUTURES
      4. 12.4 EURODOLLAR STACK HEDGE
      5. 12.5 SUMMARY
      6. APPENDIX 12: HEDGE RATIOS
      7. EXERCISES
      8. NOTES
    3. CHAPTER 13: T-bond Futures
      1. 13.1 CONTRACT SPECIFICATIONS
      2. 13.2 CONVERSION FACTOR AND CHEAPEST-TO-DELIVER
      3. 13.3 HEDGING USING T-BONDS
      4. 13.4 HEDGING: FURTHER ISSUES
      5. 13.5 MARKET TIMING
      6. 13.6 WILD CARD PLAY
      7. 13.7 PRICING T-BOND FUTURES
      8. 13.8 T-BOND FUTURES SPREADS
      9. 13.9 SUMMARY
      10. APPENDIX 13.A: HEDGING: DURATION AND MARKET TIMING
      11. APPENDIX 13.B: IMPLIED REPO RATE AND ARBITRAGE
      12. EXERCISES
      13. NOTES
  9. PART IV: OPTIONS
    1. CHAPTER 14: Options Markets
      1. 14.1 MARKET ORGANISATION
      2. 14.2 CALL OPTIONS
      3. 14.3 PUT OPTIONS
      4. 14.4 INTRINSIC VALUE AND TIME VALUE
      5. 14.5 SUMMARY
      6. EXERCISES
      7. NOTES
    2. CHAPTER 15: Uses of Options
      1. 15.1 PROTECTIVE PUT
      2. 15.2 PUT–CALL PARITY: EUROPEAN OPTIONS
      3. 15.3 GUARANTEED BOND
      4. 15.4 OTHER OPTIONS
      5. 15.5 SUMMARY
      6. EXERCISES
      7. NOTES
    3. CHAPTER 16: Black–Scholes Model
      1. 16.1 DETERMINANTS OF OPTION PRICES
      2. 16.2 BLACK–SCHOLES
      3. 16.3 ARE STOCKS LESS RISKY IN THE LONG RUN?
      4. 16.4 DELTA HEDGING
      5. 16.5 IMPLIED VOLATILITY
      6. 16.6 SUMMARY
      7. APPENDIX 16: PRICE BOUNDS ON EUROPEAN OPTIONS
      8. EXERCISES
      9. NOTES
    4. CHAPTER 17: Option Strategies
      1. 17.1 SYNTHETIC SECURITIES
      2. 17.2 BULL AND BEAR SPREADS
      3. 17.3 STRADDLE, STRANGLE, BUTTERFLY, AND CONDOR
      4. 17.4 HORIZONTAL (TIME, CALENDAR) SPREADS
      5. 17.5 SUMMARY
      6. EXERCISES
      7. NOTES
    5. CHAPTER 18: Stock Options and Stock Index Options
      1. 18.1 OPTIONS ON STOCKS
      2. 18.2 STOCK INDEX OPTIONS (SIO)
      3. 18.3 SUMMARY
      4. APPENDIX 18.A: STATIC HEDGE: INDEX PUTS
      5. APPENDIX 18.B: DYNAMIC DELTA HEDGE
      6. EXERCISES
      7. NOTES
    6. CHAPTER 19: Foreign Currency Options
      1. 19.1 CONTRACT SPECIFICATIONS
      2. 19.2 SPECULATION
      3. 19.3 HEDGING FOREIGN CURRENCY EXPOSURE
      4. 19.4 OTHER CURRENCY OPTIONS
      5. 19.5 SUMMARY
      6. EXERCISES
    7. CHAPTER 20: Options on Futures
      1. 20.1 MARKET CONVENTIONS
      2. 20.2 PRICE BOUNDS ON EUROPEAN FUTURES OPTIONS
      3. 20.3 TRADING STRATEGIES
      4. 20.4 SUMMARY
      5. EXERCISES
      6. NOTES
  10. PART V: OPTIONS PRICING
    1. CHAPTER 21: BOPM: Introduction
      1. 21.1 ONE-PERIOD BOPM
      2. 21.2 RISK-NEUTRAL VALUATION
      3. 21.3 DETERMINANTS OF CALL PREMIUM
      4. 21.4 PRICING A EUROPEAN PUT OPTION
      5. 21.5 SUMMARY
      6. APPENDIX 21: NO-ARBITRAGE CONDITIONS
      7. EXERCISES
      8. NOTES
    2. CHAPTER 22: BOPM: Implementation
      1. 22.1 GENERALISING THE BOPM
      2. 22.2 REPLICATION PORTFOLIO
      3. 22.3 BOPM TO BLACK–SCHOLES
      4. 22.4 SUMMARY
      5. APPENDIX 22: DELTA HEDGING AND ARBITRAGE
      6. EXERCISES
      7. NOTES
    3. CHAPTER 23: BOPM: Extensions
      1. 23.1 AMERICAN OPTIONS
      2. 23.2 OPTIONS ON OTHER UNDERLYING ASSETS
      3. 23.3 OPTIONS ON FUTURES CONTRACTS
      4. 23.4 OPTIONS ON DIVIDEND-PAYING STOCKS
      5. 23.5 SUMMARY
      6. APPENDIX 23: BOPM AND RISK-NEUTRAL VALUATION
      7. EXERCISES
      8. NOTES
    4. CHAPTER 24: Analysis of Black–Scholes
      1. 24.1 VOLATILITY
      2. 24.2 TESTING BLACK–SCHOLES
      3. 24.3 LIMITATIONS OF BLACK–SCHOLES
      4. 24.4 SUMMARY
      5. EXERCISES
      6. NOTES
    5. CHAPTER 25: Pricing European Options
      1. 25.1 WHAT DO N(d1) AND N(d2) REPRESENT?
      2. 25.2 EUROPEAN OPTIONS: DIVIDEND PAYING STOCKS
      3. 25.3 FOREIGN CURRENCY AND FUTURES OPTIONS
      4. 25.4 PUT–CALL PARITY
      5. 25.5 SUMMARY
      6. EXERCISES
      7. NOTE
    6. CHAPTER 26: Pricing Options: Monte Carlo Simulation
      1. 26.1 BROWNIAN MOTION: PARALLEL UNIVERSE
      2. 26.2 PRICING A EUROPEAN CALL
      3. 26.3 VARIANCE REDUCTION METHODS
      4. 26.4 THE GREEKS
      5. 26.5 MULTIPLE STOCHASTIC FACTORS
      6. 26.6 PATH-DEPENDENT OPTIONS
      7. 26.7 SUMMARY
      8. APPENDIX 26: MCS, SEVERAL STOCHASTIC VARIABLES
      9. EXERCISES
      10. NOTES
  11. PART VI: THE GREEKS
    1. CHAPTER 27: Delta Hedging
      1. 27.1 DELTA
      2. 27.2 DYNAMIC DELTA HEDGING
      3. 27.3 SUMMARY
      4. EXERCISES
      5. NOTES
    2. CHAPTER 28: The Greeks
      1. 28.1 DIFFERENT GREEKS
      2. 28.2 HEDGING WITH THE GREEKS
      3. 28.3 GREEKS AND THE BOPM
      4. 28.4 SUMMARY
      5. APPENDIX 28: BLACK–SCHOLES AND THE GREEKS
      6. EXERCISES
      7. NOTES
    3. CHAPTER 29: Portfolio Insurance
      1. 29.1 STATIC HEDGE
      2. 29.2 DYNAMIC PORTFOLIO INSURANCE
      3. 29.3 SUMMARY
      4. EXERCISES
      5. NOTE
  12. PART VII: ADVANCED OPTIONS
    1. CHAPTER 30: Other Options
      1. 30.1 CORPORATE EQUITY AND DEBT
      2. 30.2 WARRANTS
      3. 30.3 EQUITY COLLAR
      4. 30.4 SUMMARY
      5. EXERCISES
      6. NOTES
    2. CHAPTER 31: Exotic Options
      1. 31.1 THREE-PERIOD BOPM
      2. 31.2 ASIAN OPTIONS
      3. 31.3 OTHER EXOTICS: LOOKBACKS, BARRIER, COMPOUND, AND CHOOSER
      4. 31.4 SUMMARY
      5. EXERCISES
      6. NOTES
    3. CHAPTER 32: Energy and Weather Derivatives
      1. 32.1 ENERGY CONTRACTS
      2. 32.2 HEDGING WITH ENERGY FUTURES
      3. 32.3 ENERGY SWAPS
      4. 32.4 WEATHER DERIVATIVES
      5. 32.5 REINSURANCE AND CAT BONDS
      6. 32.6 SUMMARY
      7. EXERCISES
      8. NOTES
  13. PART VIII: SWAPS
    1. CHAPTER 33: Interest Rate Swaps
      1. 33.1 USING INTEREST RATE SWAPS
      2. 33.2 CASH FLOWS IN A SWAP
      3. 33.3 SETTLEMENT AND PRICE QUOTES
      4. 33.4 TERMINATING A SWAP
      5. 33.5 COMPARATIVE ADVANTAGE
      6. 33.6 SUMMARY
      7. APPENDIX 33: COMPARATIVE ADVANTAGE WITH SWAP DEALER
      8. EXERCISES
      9. NOTES
    2. CHAPTER 34: Pricing Interest Rate Swaps
      1. 34.1 CASH FLOWS IN A SWAP
      2. 34.2 FLOATING RATE NOTE (FRN)
      3. 34.3 PRICING A SWAP: SHORT METHOD
      4. 34.4 PRICING A SWAP: FORWARD RATE METHOD
      5. 34.5 MARKET VALUE OF A SWAP
      6. 34.6 SWAP DELTA AND PVBP
      7. 34.7 SUMMARY
      8. APPENDIX 34: VALUE OF AN FRN USING ARBITRAGE
      9. EXERCISES
      10. NOTES
    3. CHAPTER 35: Other Interest Rate Swaps
      1. 35.1 SWAP DEALS
      2. 35.2 PRICING NON-STANDARD SWAPS
      3. 35.3 HEDGING INTEREST RATE SWAPS
      4. 35.4 CREDIT RISK
      5. 35.5 SUMMARY
      6. EXERCISES
      7. NOTES
    4. CHAPTER 36: Currency Swaps
      1. 36.1 USES
      2. 36.2 PRICING A FIXED-FIXED CURRENCY SWAP
      3. 36.3 VALUING A FIXED-FIXED CURRENCY SWAP
      4. 36.4 SUMMARY
      5. APPENDIX 36.A: PRICING A CURRENCY SWAP
      6. APPENDIX 36.B: VALUATION OF A CURRENCY SWAP
      7. EXERCISES
      8. NOTES
    5. CHAPTER 37: Equity Swaps
      1. 37.1 EQUITY-FOR-LIBOR: FIXED NOTIONAL PRINCIPAL
      2. 37.2 UNHEDGED CROSS-CURRENCY EQUITY SWAP
      3. 37.3 HEDGED CROSS-CURRENCY EQUITY SWAP
      4. 37.4 PRICING EQUITY SWAPS
      5. 37.5 SUMMARY
      6. APPENDIX 37: VALUATION OF EQUITY-FOR-LIBOR SWAP
      7. EXERCISES
      8. NOTES
  14. PART IX: FIXED INCOME DERIVATIVES
    1. CHAPTER 38: T-Bond Option, Caps, Floors and Collar
      1. 38.1 OPTIONS ON T-BONDS AND EURODOLLARS
      2. 38.2 CAPLETS AND FLOORLETS
      3. 38.3 INTEREST RATE CAP
      4. 38.4 INTEREST RATE FLOOR
      5. 38.5 INTEREST RATE COLLAR
      6. 38.6 SUMMARY
      7. EXERCISES
      8. NOTES
    2. CHAPTER 39: Swaptions, Forward Swaps, and MBS
      1. 39.1 SWAPTIONS
      2. 39.2 FORWARD SWAPS
      3. 39.3 MORTGAGE-BACKED SECURITIES (MBS)
      4. 39.4 HEDGING FIXED INCOME DERIVATIVES
      5. 39.5 SUMMARY
      6. EXERCISES
      7. NOTES
    3. CHAPTER 40: Pricing Fixed Income Options: Black's Model and MCS
      1. 40.1 BLACK'S MODEL: EUROPEAN OPTIONS
      2. 40.2 PRICING A CAPLET USING MCS
      3. 40.3 EUROPEAN SWAPTION: BLACK'S MODEL
      4. 40.4 SUMMARY
      5. EXERCISES
      6. NOTE
    4. CHAPTER 41: Pricing Fixed Income Derivatives: BOPM
      1. 41.1 NO-ARBITRAGE APPROACH: BOPM
      2. 41.2 PRICING A COUPON BOND
      3. 41.3 PRICING OPTIONS
      4. 41.4 PRICING A CALLABLE BOND
      5. 41.5 PRICING CAPS
      6. 41.6 PRICING FRAS
      7. 41.7 PRICING A SWAPTION
      8. 41.8 PRICING FRNS WITH EMBEDDED OPTIONS
      9. 41.9 MORE LATTICES
      10. 41.10 SUMMARY
      11. EXERCISES
      12. NOTES
  15. PART X: CREDIT DERIVATIVES
    1. CHAPTER 42: Credit Default Swaps (CDS)
      1. 42.1 CREDIT RISK AND CDS
      2. 42.2 SPECULATION WITH CDS
      3. 42.3 CONTRACT DETAILS
      4. 42.4 PRICING AND VALUATION
      5. 42.5 BOND YIELDS AND THE CDS SPREAD
      6. 42.6 CREDIT INDICES AND OTHER CDS CONTRACTS
      7. 42.7 DERIVATIVES ON THE CDS SPREAD
      8. 42.8 SUMMARY
      9. EXERCISES
      10. NOTES
    2. CHAPTER 43: Securitisation, ABSs and CDOs
      1. 43.1 ABS AND ABS-CDO
      2. 43.2 CREDIT ENHANCEMENT
      3. 43.3 LOSSES ON ABS AND ABS-CDO
      4. 43.4 SUB-PRIME CRISIS 2007–8
      5. 43.5 SYNTHETIC CDO
      6. 43.6 SINGLE TRANCHE TRADING
      7. 43.7 TOTAL RETURN SWAP
      8. 43.8 SUMMARY
      9. EXERCISES
      10. NOTES
  16. PART XI: MARKET RISK
    1. CHAPTER 44: Value at Risk
      1. 44.1 INTRODUCTION
      2. 44.2 VALUE AT RISK (VAR)
      3. 44.3 FORECASTING VOLATILITY
      4. 44.4 BACKTESTING
      5. 44.5 CAPITAL ADEQUACY
      6. 44.6 SUMMARY
      7. EXERCISES
      8. NOTES
    2. CHAPTER 45: VaR: Other Portfolios
      1. 45.1 SINGLE INDEX MODEL
      2. 45.2 VaR FOR COUPON BONDS
      3. 45.3 VaR: OPTIONS
      4. 45.4 SUMMARY
      5. APPENDIX 45.A: VaR FOR FOREIGN ASSETS
      6. APPENDIX 45.B: SINGLE INDEX MODEL (SIM)
      7. APPENDIX 45.C: CASH FLOW MAPPING
      8. EXERCISES
      9. NOTES
    3. CHAPTER 46: VaR: Alternative Measures
      1. 46.1 HISTORICAL SIMULATION
      2. 46.2 BOOTSTRAPPING
      3. 46.3 MONTE CARLO SIMULATION
      4. 46.4 ALTERNATIVE METHODS
      5. 46.5 SUMMARY
      6. EXERCISES
      7. NOTES
  17. PART XII: PRICE DYNAMICS
    1. CHAPTER 47: Asset Price Dynamics
      1. 47.1 STOCHASTIC PROCESSES
      2. 47.2 GEOMETRIC BROWNIAN MOTION (GBM) AND ITO'S LEMMA
      3. 47.3 DISTRIBUTION OF LOG STOCK PRICE AND STOCK PRICE
      4. 47.4 SUMMARY
      5. APPENDIX 47: ITO'S LEMMA
      6. EXERCISES
      7. NOTES
    2. CHAPTER 48: Black–Scholes PDE
      1. 48.1 RISK-NEUTRAL VALUATION AND BLACK–SCHOLES PDE
      2. 48.2 FINITE DIFFERENCE METHODS
      3. 48.3 SUMMARY
      4. APPENDIX 48: DERIVATION OF BLACK–SCHOLES PDE
      5. EXERCISES
      6. NOTE
    3. CHAPTER 49: Equilibrium Models: Term Structure
      1. 49.1 RISK-NEUTRAL VALUATION
      2. 49.2 MODELS OF THE SHORT-RATE
      3. 49.3 PRICING USING CONTINUOUS TIME MODELS
      4. 49.4 BOND PRICES AND DERIVATIVE PRICES
      5. 49.5 SUMMARY
      6. EXERCISES
      7. NOTES
  18. Glossary
  19. Bibliography
  20. Author Index
  21. Subject Index
  22. End User License Agreement
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