What is included with this book?
Preface | p. xiii |
Introduction | p. 1 |
Derivative Markets and Instruments | p. 2 |
Options | p. 2 |
Forward Contracts | p. 3 |
Futures Contracts | p. 3 |
Swaps and Other Derivatives | p. 4 |
The Underlying Asset | p. 4 |
Important Concepts in Financial and Derivative Markets | p. 5 |
Risk Preference | p. 5 |
Short Selling | p. 5 |
Repurchase Agreements | p. 6 |
Return and Risk | p. 6 |
Market Efficiency and Theoretical Fair Value | p. 8 |
Fundamental Linkages between Spot and Derivative Markets | p. 9 |
Arbitrage and the Law of One Price | p. 10 |
The Storage Mechanism: Spreading Consumption across Time | p. 11 |
Delivery and Settlement | p. 11 |
The Role of Derivative Markets | p. 12 |
Risk Management | p. 12 |
Price Discovery | p. 12 |
Operational Advantages | p. 13 |
Market Efficiency | p. 13 |
Criticisms of Derivative Markets | p. 13 |
Misuses of Derivatives | p. 14 |
Derivatives and Your Career | p. 14 |
Sources of Information on Derivatives | p. 15 |
Book Overview | p. 15 |
Organization of the Book | p. 15 |
Key Features of the Book | p. 16 |
Specific New Features of the Seventh Edition | p. 17 |
Use of the Book | p. 17 |
Summary | p. 18 |
Key Terms | p. 18 |
Further Reading | p. 19 |
Questions and Problems | p. 19 |
Options | p. 21 |
Structure of Options Markets | p. 22 |
Development of Options Markets | p. 23 |
Call Options | p. 24 |
Put Options | p. 24 |
Over-the-Counter Options Market | p. 25 |
Organized Options Trading | p. 26 |
Listing Requirements | p. 27 |
Contract Size | p. 27 |
Exercise Prices | p. 28 |
Expiration Dates | p. 28 |
Position and Exercise Limits | p. 29 |
Options Exchanges and Trading Activity | p. 29 |
Option Traders | p. 30 |
Market Maker | p. 31 |
Floor Broker | p. 31 |
Order Book Official | p. 32 |
Other Option Trading Systems | p. 32 |
Off-Floor Option Traders | p. 33 |
Cost and Profitability of Exchange Membership | p. 33 |
Mechanics of Trading | p. 34 |
Placing an Opening Order | p. 34 |
Role of the Clearinghouse | p. 34 |
Placing an Offsetting Order | p. 36 |
Exercising an Option | p. 37 |
Option Price Quotations | p. 37 |
Types of Options | p. 40 |
Stock Options | p. 40 |
Index Options | p. 40 |
Currency Options | p. 41 |
Other Types of Options | p. 41 |
Real Options | p. 42 |
Transaction Costs in Option Trading | p. 43 |
Floor Trading and Clearing Fees | p. 43 |
Commissions | p. 43 |
Bid-Ask Spread | p. 43 |
Other Transaction Costs | p. 44 |
Regulation of Options Markets | p. 44 |
Summary | p. 46 |
Key Terms | p. 46 |
Further Reading | p. 46 |
Questions and Problems | p. 47 |
Margin Requirements | p. 48 |
Margin Requirements on Stock Transactions | p. 48 |
Margin Requirements on Option Purchases | p. 48 |
Margin Requirements on the Uncovered Sale of Options | p. 48 |
Margin Requirements on Covered Calls | p. 49 |
Questions and Problem | p. 49 |
Taxation of Option Transactions | p. 50 |
Taxation of Long Call Transactions | p. 50 |
Taxation of Short Call Transactions | p. 50 |
Taxation of Long Put Transactions | p. 51 |
Taxation of Short Put Transactions | p. 51 |
Taxation of Non-Equity Options | p. 51 |
Wash and Constructive Sales | p. 52 |
Questions and Problems | p. 52 |
Principles of Option Pricing | p. 54 |
Basic Notation and Terminology | p. 55 |
Principles of Call Option Pricing | p. 57 |
Minimum Value of a Call | p. 57 |
Maximum Value of a Call | p. 59 |
Value of a Call at Expiration | p. 59 |
Effect of Time to Expiration | p. 60 |
Effect of Exercise Price | p. 62 |
Lower Bound of a European Call | p. 65 |
American Call Versus European Call | p. 67 |
Early Exercise of American Calls on Dividend-Paying Stocks | p. 69 |
Effect of Interest Rates | p. 69 |
Effect of Stock Volatility | p. 70 |
Principles of Put Option Pricing | p. 70 |
Minimum Value of a Put | p. 71 |
Maximum Value of a Put | p. 72 |
Value of a Put at Expiration | p. 72 |
Effect of Time to Expiration | p. 73 |
The Effect of Exercise Price | p. 75 |
Lower Bound of a European Put | p. 76 |
American Put Versus European Put | p. 79 |
Early Exercise of American Puts | p. 79 |
Put-Call Parity | p. 79 |
Effect of Interest Rates | p. 82 |
Effect of Stock Volatility | p. 83 |
Summary | p. 84 |
Key Terms | p. 86 |
Further Reading | p. 86 |
Questions and Problems | p. 87 |
The Dynamics of Option Boundary Conditions: A Learning Exercise | p. 90 |
Option Pricing Models: The Binomial Model | p. 92 |
One-Period Binomial Model | p. 93 |
Illustrative Example | p. 96 |
Hedge Portfolio | p. 97 |
Overpriced Call | p. 98 |
Underpriced Call | p. 100 |
Two-Period Binomial Model | p. 100 |
Illustrative Example | p. 102 |
Hedge Portfolio | p. 103 |
Mispriced Call in the Two-Period World | p. 105 |
Extensions of the Binomial Model | p. 106 |
Pricing Put Options | p. 106 |
American Puts and Early Exercise | p. 108 |
Dividends, European Calls, American Calls, and Early Exercise | p. 108 |
Extending the Binomial Model to n Periods | p. 113 |
Behavior of the Binomial Model for Large n and Fixed Option Life | p. 115 |
Alternative Specifications of the Binomial Model | p. 117 |
Advantages of the Binomial Model | p. 119 |
Calculating the Binomial Price with the Excel Spreadsheet BSMbin7e.xls | p. 120 |
Summary | p. 121 |
Key Terms | p. 122 |
Further Reading | p. 122 |
Questions and Problems | p. 123 |
Option Pricing Models: The Black-Scholes-Merton Model | p. 125 |
Origins of the Black-Scholes-Merton Formula | p. 125 |
Black-Scholes-Merton Model as the Limit of the Binomial Model | p. 126 |
Assumptions of the Black-Scholes-Merton Model | p. 128 |
Stock Prices Behave Randomly and Evolve According to a Lognormal Distribution | p. 128 |
Risk-Free Rate and Volatility of the Log Return on the Stock are Constant Throughout the Option's Life | p. 131 |
No Taxes or Transaction Costs | p. 132 |
Stock Pays No Dividends | p. 133 |
Options Are European | p. 133 |
A Nobel Formula | p. 133 |
Digression on Using the Normal Distribution | p. 134 |
Numerical Example | p. 135 |
Calculating the Black-Scholes-Merton Price with the Excel Spreadsheet BSMbin7e.xls | p. 137 |
Characteristics of the Black-Scholes-Merton Formula | p. 138 |
Variables in the Black-Scholes-Merton Model | p. 141 |
Stock Price | p. 142 |
Exercise Price | p. 145 |
Risk-Free Rate | p. 146 |
Volatility or Standard Deviation | p. 147 |
Time to Expiration | p. 149 |
Black-Scholes-Merton Model When the Stock Pays Dividends | p. 151 |
Known Discrete Dividends | p. 151 |
Known Continuous Dividend Yield | p. 151 |
Black-Scholes-Merton Model and Some Insights into American Call Options | p. 153 |
Estimating the Volatility | p. 154 |
Historical Volatility | p. 155 |
Implied Volatility | p. 155 |
Calculating the Historical Volatility with the Excel Spreadsheet Hisv7e.xls | p. 157 |
Put Option Pricing Models | p. 163 |
Managing the Risk of Options | p. 166 |
Summary | p. 171 |
Key Terms | p. 172 |
Further Reading | p. 172 |
Questions and Problems | p. 174 |
A Shortcut to the Calculation of Implied Volatility | p. 177 |
The BSMbwin7e.exe Windows Software | p. 179 |
Basic Option Strategies | p. 181 |
Terminology and Notation | p. 182 |
Profit Equations | p. 182 |
Different Holding Periods | p. 184 |
Assumptions | p. 184 |
Stock Transactions | p. 185 |
Buy Stock | p. 185 |
Sell Short Stock | p. 185 |
Call Option Transactions | p. 187 |
Buy a Call | p. 187 |
Write a Call | p. 191 |
Put Option Transactions | p. 193 |
Buy a Put | p. 193 |
Write a Put | p. 196 |
Calls and Stock: The Covered Call | p. 199 |
Some General Considerations with Covered Calls | p. 203 |
Puts and Stock: The Protective Put | p. 204 |
Synthetic Puts and Calls | p. 208 |
Analyzing Option Strategies with the Excel Spreadsheet Stratlyz7e.xls | p. 211 |
Summary | p. 215 |
Key Terms | p. 215 |
Questions and Problems | p. 215 |
Advanced Option Strategies | p. 218 |
Option Spreads: Basic Concepts | p. 219 |
Why Investors Use Option Spreads | p. 219 |
Notation | p. 220 |
Money Spreads | p. 221 |
Bull Spreads | p. 221 |
Bear Spreads | p. 224 |
A Note about Call Bear Spreads and Put Bull Spreads | p. 226 |
Collars | p. 226 |
Butterfly Spreads | p. 230 |
Calendar Spreads | p. 234 |
Time Value Decay | p. 236 |
Ratio Spreads | p. 238 |
Straddles | p. 239 |
Box Spreads | p. 244 |
Summary | p. 246 |
Key Terms | p. 246 |
Further Reading | p. 247 |
Questions and Problems | p. 247 |
Forwards, Futures, and Swaps | p. 251 |
The Structure of Forward and Futures Markets | p. 252 |
Development of Forward and Futures Markets | p. 253 |
Chicago Futures Markets | p. 253 |
Development of Financial Futures | p. 254 |
Development of Options on Futures Markets | p. 255 |
Parallel Development of Over-the-Counter Markets | p. 256 |
Over-the-Counter Forward Market | p. 256 |
Organized Futures Trading | p. 257 |
Contract Development | p. 258 |
Contract Terms and Conditions | p. 258 |
Delivery Terms | p. 259 |
Daily Price Limits and Trading Halts | p. 259 |
Other Exchange Responsibilities | p. 260 |
Futures Exchanges | p. 260 |
Futures Traders | p. 262 |
General Classes of Futures Traders | p. 262 |
Classification by Trading Strategy | p. 262 |
Classification by Trading Style | p. 263 |
Off-Floor Futures Traders | p. 264 |
Costs and Profitability of Exchange Membership | p. 264 |
Forward Market Traders | p. 265 |
Mechanics of Futures Trading | p. 265 |
Placing an Order | p. 265 |
Role of the Clearinghouse | p. 266 |
Daily Settlement | p. 267 |
Delivery and Cash Settlement | p. 269 |
Futures Price Quotations | p. 271 |
Types of Futures Contracts | p. 271 |
Agricultural Commodities | p. 272 |
Natural Resources | p. 272 |
Miscellaneous Commodities | p. 272 |
Foreign Currencies | p. 272 |
Federal Funds and Eurodollars | p. 273 |
Treasury Notes and Bonds | p. 273 |
Swap Futures | p. 273 |
Equities | p. 273 |
Managed Funds | p. 275 |
Hedge Funds | p. 276 |
Options on Futures | p. 276 |
Transaction Costs in Forward and Futures Trading | p. 277 |
Commissions | p. 277 |
Bid-Ask Spread | p. 277 |
Delivery Costs | p. 277 |
Regulation of Futures and Forward Markets | p. 278 |
Summary | p. 279 |
Key Terms | p. 279 |
Further Reading | p. 280 |
Questions and Problems | p. 280 |
Taxation of Futures Transactions in the United States | p. 282 |
Questions and Problems | p. 283 |
Principles of Pricing Forwards, Futures, and Options on Futures | p. 284 |
Generic Carry Arbitrage | p. 285 |
Concept of Price versus Value | p. 285 |
Value of a Forward Contract | p. 286 |
Price of a Forward Contract | p. 288 |
Value of a Futures Contract | p. 288 |
Price of a Futures Contract | p. 289 |
Forward versus Futures Prices | p. 290 |
Carry Arbitrage When Underlying Generates Cash Flows | p. 292 |
Stock Indices and Dividends | p. 292 |
Foreign Currencies and Foreign Interest Rates: Interest Rate Parity | p. 295 |
Commodities and Storage Costs | p. 297 |
Pricing Models and Risk Premiums | p. 298 |
Spot Prices, Risk Premiums, and Carry Arbitrage for Generic Assets | p. 298 |
Forward/Futures Pricing Revisited | p. 299 |
Futures Prices and Risk Premia | p. 305 |
Put-Call-Forward/Futures Parity | p. 309 |
Pricing Options on Futures | p. 311 |
Intrinsic Value of an American Option on Futures | p. 311 |
Lower Bound of a European Option on Futures | p. 312 |
Put-Call Parity of Options on Futures | p. 314 |
Early Exercise of Call and Put Options on Futures | p. 315 |
Black Futures Option Pricing Model | p. 317 |
Summary | p. 319 |
Key Terms | p. 321 |
Further Reading | p. 321 |
Questions and Problems | p. 322 |
Futures Arbitrage Strategies | p. 325 |
Short-Term Interest Rate Arbitrage | p. 326 |
Carry Arbitrage and the Implied Repo Rate | p. 326 |
Federal Funds Futures Carry Arbitrage and the Implied Repo Rate | p. 327 |
Eurodollar Arbitrage | p. 329 |
Intermediate- and Long-Term Interest Rate Arbitrage | p. 330 |
Determining the Cheapest-to-Deliver Bond on the Treasury Bond Futures Contract | p. 332 |
Delivery Options | p. 334 |
Implied Repo, Carry Arbitrage and Treasury Bond Futures | p. 337 |
Identifying the Cheapest-to-Deliver Bond with the Excel Spreadsheet CTD7e.xls | p. 338 |
Treasury Bond Futures Spreads and the Implied Repo Rate | p. 340 |
Stock Index Arbitrage | p. 341 |
Foreign Exchange Arbitrage | p. 345 |
Summary | p. 346 |
Key Terms | p. 347 |
Further Reading | p. 348 |
Questions and Problems | p. 348 |
Determining the CBOT Treasury Bond Conversion Factor | p. 351 |
Determining the CBOT Conversion Factor with the Excel Spreadsheet CF7e.xls | p. 352 |
Forward and Futures Hedging, Spread, and Target Strategies | p. 353 |
Why Hedge? | p. 354 |
Hedging Concepts | p. 355 |
Short Hedge and Long Hedge | p. 355 |
The Basis | p. 356 |
Some Risks of Hedging | p. 360 |
Contract Choice | p. 361 |
Margin Requirements and Marking to Market | p. 364 |
Determination of the Hedge Ratio | p. 365 |
Minimum Variance Hedge Ratio | p. 365 |
Price Sensitivity Hedge Ratio | p. 367 |
Stock Index Futures Hedging | p. 370 |
Hedging Strategies | p. 371 |
Foreign Currency Hedges | p. 371 |
Intermediate- and Long-Term Interest Rate Hedges | p. 373 |
Spread Strategies | p. 382 |
Intramarket Spreads | p. 383 |
Intermarket Spreads | p. 386 |
Target Strategies | p. 388 |
Target Duration with Bond Futures | p. 388 |
Alpha Capture | p. 391 |
Target Beta with Stock Index Futures | p. 393 |
Tactical Asset Allocation Using Stock and Bond Futures | p. 394 |
Summary | p. 398 |
Key Terms | p. 399 |
Further Reading | p. 399 |
Questions and Problems | p. 400 |
Taxation of Hedging | p. 404 |
Swaps | p. 405 |
Interest Rate Swaps | p. 408 |
Structure of a Typical Interest Rate Swap | p. 408 |
Pricing and Valuation of Interest Rate Swaps | p. 410 |
Interest Rate Swap Strategies | p. 416 |
Currency Swaps | p. 420 |
Structure of a Typical Currency Swap | p. 421 |
Pricing and Valuation of Currency Swaps | p. 423 |
Currency Swap Strategies | p. 428 |
Equity Swaps | p. 430 |
Structure of a Typical Equity Swap | p. 431 |
Pricing and Valuation of Equity Swaps | p. 432 |
Equity Swap Strategies | p. 436 |
Some Final Words about Swaps | p. 437 |
Summary | p. 438 |
Key Terms | p. 439 |
Further Reading | p. 439 |
Questions and Problems | p. 439 |
Advanced Topics | p. 443 |
Interest Rate Forwards and Options | p. 444 |
Forward Rate Agreements | p. 445 |
Structure and Use of a Typical FRA | p. 446 |
Pricing and Valuation of FRAs | p. 448 |
Applications of FRAs | p. 450 |
Interest Rate Options | p. 453 |
Structure and Use of a Typical Interest Rate Option | p. 454 |
Pricing and Valuation of Interest Rate Options | p. 455 |
Interest Rate Option Strategies | p. 457 |
Interest Rate Caps, Floors, and Collars | p. 461 |
Interest Rate Options, FRAs, and Swaps | p. 466 |
Interest Rate Swaptions and Forward Swaps | p. 467 |
Structure of a Typical Interest Rate Swaption | p. 468 |
Equivalence of Swaptions and Options on Bonds | p. 471 |
Pricing Swaptions | p. 471 |
Forward Swaps | p. 472 |
Applications of Swaptions and Forward Swaps | p. 473 |
Summary | p. 475 |
Key Terms | p. 475 |
Further Reading | p. 476 |
Questions and Problems | p. 476 |
Advanced Derivatives and Strategies | p. 480 |
Advanced Equity Derivatives and Strategies | p. 481 |
Portfolio Insurance | p. 481 |
Equity Forwards | p. 487 |
Equity Warrants | p. 490 |
Equity-Linked Debt | p. 491 |
Advanced Interest Rate Derivatives | p. 491 |
Structured Notes | p. 492 |
Mortgage-Backed Securities | p. 493 |
Exotic Options | p. 498 |
Digital and Chooser Options | p. 499 |
Path-Dependent Options | p. 502 |
Other Exotic Options | p. 508 |
Some Unusual Derivatives | p. 509 |
Electricity Derivatives | p. 509 |
Weather Derivatives | p. 509 |
Summary | p. 511 |
Key Terms | p. 511 |
Further Reading | p. 512 |
Questions and Problems | p. 513 |
Monte Carlo Simulation | p. 516 |
Financial Risk Management Techniques and Applications | p. 518 |
Why Practice Risk Management? | p. 519 |
Impetus for Risk Management | p. 519 |
Benefits of Risk Management | p. 520 |
Managing Market Risk | p. 521 |
Delta Hedging | p. 523 |
Gamma Hedging | p. 524 |
Vega Hedging | p. 527 |
Value at Risk (VAR) | p. 528 |
A Comprehensive Calculation of VAR | p. 534 |
Benefits and Criticisms of VAR | p. 536 |
Extensions of VAR | p. 537 |
Managing Credit Risk | p. 538 |
Credit Risk as an Option | p. 539 |
Credit Risk of Derivatives | p. 541 |
Netting | p. 544 |
Credit Derivatives | p. 545 |
Other Types of Risks | p. 551 |
Summary | p. 555 |
Key Terms | p. 555 |
Further Reading | p. 556 |
Questions and Problems | p. 556 |
Managing Risk in an Organization | p. 559 |
The Structure of the Risk Management Industry | p. 560 |
End Users | p. 560 |
Dealers | p. 560 |
Other Participants in the Risk Management Industry | p. 561 |
Organizing the Risk Management Function in a Company | p. 561 |
Risk Management Accounting | p. 566 |
Fair Value Hedges | p. 567 |
Cash Flow Hedges | p. 568 |
Foreign Investment Hedges | p. 570 |
Speculation | p. 570 |
Some Problems in the Application of FAS 133 | p. 570 |
Disclosure | p. 571 |
Avoiding Derivatives Losses | p. 571 |
Metallgesellschaft: To Hedge or Not to Hedge? | p. 571 |
Orange County, California: Playing the Odds | p. 574 |
Barings PLC: How One Man Blew Up a Bank | p. 576 |
Procter & Gamble: Going Up in Suds | p. 578 |
Risk Management Industry Standards | p. 579 |
Responsibilities of Senior Management | p. 579 |
Summary | p. 585 |
Key Terms | p. 586 |
Further Reading | p. 586 |
Questions and Problems | p. 587 |
List of Formulas | p. 589 |
References | p. 598 |
Glossary | p. 619 |
Index | p. 641 |
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