Futures, Options, and Swaps

by Quail, Rob; Overdahl, James A.

• ISBN13: 9781405150491
• ISBN10: 1405150491
• Edition: 5th
• Format: Hardcover
• Copyright: 2007-02-27
• Publisher: Wiley-Blackwell

Summary

A new and updated edition of the most readable, comprehensive text available on derivatives markets. Utilizes an even more applied approach than previous editions Provides an excellent balance between introductory and advanced topics Extensively updated to incorporate and explicate development in the field including the areas of electronic trading platforms, globalization of markets, hedge funds, financial scandals involving derivatives, and government regulation Revised to include over 50 text boxes with applied vignettes on topical issues, product profiles, and historical anecdotes

Author Biography

Robert W. Kolb holds the Frank W. Considine Chair in Applied Ethics at Loyola University Chicago. He was formerly Assistant Dean for Business and Society (2003–2006) at the University of Colorado, and John S. and James L. Knight Professor of Finance at the University of Miami. He is author and co-author of numerous texts in finance, including Futures, Options, and Swaps, 5e (with James A. Overdahl, Blackwell, 2007) and Understanding Futures Markets, 6e (with James A. Overdahl, Blackwell, 2006).

James A. Overdahl is Chief Economist at the Commodity Futures Trading Commission in Washington, D.C., and has held senior positions at the Risk Analysis Division at the Office of the Comptroller of the Currency and at the Securities and Exchange Commission. He has been an adjunct professor of finance at Georgetown University, the University of Maryland, George Washington University, and Johns Hopkins University.

Table of Contents

Preface	p. xvi
Acknowledgments	p. xvii
Introduction	p. 1
Overview	p. 1
Derivatives defined	p. 1
Applications of financial derivatives	p. 7
The concept of arbitrage	p. 8
The organization of the text	p. 9
Exercises	p. 11
Notes	p. 12
Futures markets	p. 13
Overview	p. 13
Futures markets	p. 13
Exchanges and types of futures	p. 27
Purposes of futures markets	p. 31
Regulation of futures markets	p. 34
Taxation of futures trading	p. 42
Brokers, advisors, and commodity fund managers	p. 42
The changing environment of futures markets	p. 45
Market manipulation	p. 58
Conclusion	p. 65
Exercises	p. 65
Notes	p. 66
Futures prices	p. 69
Overview	p. 69
Reading futures prices	p. 69
The basis and spreads	p. 75
Models of futures prices	p. 80
Futures prices and expectations	p. 98
Futures prices and risk aversion	p. 100
Characteristics of futures prices	p. 104
Conclusion	p. 111
Exercises	p. 112
Notes	p. 113
Using futures markets	p. 116
Overview	p. 116
Price discovery	p. 116
Speculation	p. 119
Speculative profits	p. 128
Hedging	p. 133
Conclusion	p. 147
Exercises	p. 148
Notes	p. 148
Interest rate futures: an introduction	p. 152
Overview	p. 152
Short-maturity interest rate futures contracts	p. 152
Longer-maturity interest rate futures	p. 158
The pricing of interest rate futures contracts	p. 166
Speculating with interest rate futures	p. 175
Hedging with interest rate futures	p. 178
Conclusion	p. 185
Exercises	p. 185
Notes	p. 187
Interest rate futures: refinements	p. 188
Overview	p. 188
The T-bond futures contract in detail	p. 188
Seller's options in T-bond futures	p. 198
The efficiency of the interest rate futures market	p. 202
Applications: Eurodollar and T-bill futures	p. 209
Hedging with T-bond futures	p. 219
Conclusion	p. 237
Exercises	p. 238
Notes	p. 239
Security futures products: an introduction	p. 241
Overview	p. 241
The indexes	p. 241
Stock index futures contracts	p. 245
Stock index futures prices	p. 247
Index arbitrage and program trading	p. 252
Speculating with stock index futures	p. 256
Single stock futures	p. 259
Risk management with security futures products	p. 261
Conclusion	p. 264
Exercises	p. 265
Notes	p. 266
Security futures products: refinements	p. 268
Overview	p. 268
Stock index futures prices	p. 268
Real-world program trading	p. 272
Hedging with stock index futures	p. 276
Asset allocation	p. 282
Hedge fund uses of stock index futures	p. 284
Portfolio insurance	p. 285
Index futures and stock market volatility	p. 288
Index futures and stock market crashes	p. 290
Conclusion	p. 295
Exercises	p. 295
Notes	p. 296
Foreign exchange futures	p. 298
Overview	p. 298
Price quotations	p. 298
Geographic and cross-rate arbitrage	p. 300
Forward and futures market characteristics	p. 303
The European Monetary Union	p. 305
Determinants of foreign exchange rates	p. 306
Forward and futures prices for foreign exchange	p. 309
More futures price parity relationships	p. 309
Foreign exchange forecasting accuracy	p. 316
The efficiency of foreign exchange futures markets	p. 317
Speculation in foreign exchange futures	p. 319
Hedging with foreign exchange futures	p. 322
Conclusion	p. 326
Exercises	p. 327
Notes	p. 329
The options market	p. 330
Overview	p. 330
An option example	p. 330
Moneyness	p. 331
American and European options	p. 332
Why trade options?	p. 332
The option contract	p. 333
The options marketplace	p. 333
Option trading procedures	p. 342
The clearinghouse	p. 346
Margins	p. 347
Commissions	p. 349
Taxation	p. 350
Conclusion	p. 353
Exercises	p. 353
Notes	p. 355
Option payoffs and option strategies	p. 357
Overview	p. 357
Stocks and bonds	p. 357
Option notation	p. 360
European and American option values at expiration	p. 361
Buy or sell a call option	p. 361
Call options at expiration and arbitrage	p. 365
Buy or sell a put option	p. 367
Moneyness	p. 369
Option combinations	p. 370
Combining options with bonds and stocks	p. 389
Conclusion	p. 401
Exercises	p. 401
Notes	p. 404
Bounds on option prices	p. 406
Overview	p. 406
The boundary space for call and put options	p. 406
Relationships between call option prices	p. 409
Relationships between put option prices	p. 416
Option prices and the interest rate	p. 423
Option prices and stock price movements	p. 425
Option prices and the riskiness of stocks	p. 429
Conclusion	p. 431
Exercises	p. 431
Notes	p. 433
European option pricing	p. 434
Overview	p. 434
The single-period binomial model	p. 434
The multi-period binomial model	p. 434
Stock price movements	p. 437
The binomial approach to the Black-Scholes model	p. 447
The Black-Scholes option pricing model	p. 449
Inputs for the Black-Scholes model	p. 451
European options and dividends	p. 456
Tests of the option pricing model	p. 465
Conclusion	p. 468
Exercises	p. 469
Notes	p. 473
Option sensitivities and option hedging	p. 476
Overview	p. 476
Option sensitivities in the Merton and Black-Scholes models	p. 476
Delta	p. 480
Theta	p. 485
Vega	p. 487
Rho	p. 488
Gamma	p. 490
Creating neutral portfolios	p. 493
Option sensitivities and option trading strategies	p. 495
Conclusion	p. 505
Exercises	p. 505
Note	p. 511
American option pricing	p. 512
Overview	p. 512
American versus European options	p. 512
American versus European calls	p. 514
Dividend capture strategies	p. 515
Pseudo-American call option pricing	p. 517
Exact American call option pricing	p. 518
Analytic approximations of American option prices	p. 523
The binomial model and American option prices	p. 526
Conclusion	p. 537
Exercises	p. 537
Notes	p. 539
Options on stock indexes, foreign currency, and futures	p. 540
Overview	p. 540
European option pricing	p. 540
Option sensitivities	p. 550
Pricing American options	p. 551
Conclusion	p. 564
Exercises	p. 564
Notes	p. 565
The options approach to corporate securities	p. 566
Overview	p. 566
Equity and a pure discount bond	p. 566
Senior and subordinated debt	p. 570
Callable bonds	p. 571
Convertible bonds	p. 573
Warrants	p. 574
Conclusion	p. 576
Exercises	p. 576
Notes	p. 578
Exotic options	p. 579
Overview	p. 579
Assumptions of the analysis and the pricing environment	p. 579
Forward-start options	p. 580
Compound options	p. 581
Chooser options	p. 584
Barrier options	p. 587
Binary options	p. 594
Lookback options	p. 601
Average price options	p. 605
Exchange options	p. 606
Rainbow options	p. 609
Conclusion	p. 615
Exercises	p. 616
Notes	p. 616
Interest rate options	p. 618
Overview	p. 618
Interest rate options: markets and instruments	p. 618
The term structure of interest rates	p. 623
Stripped Treasury securities and forward rate agreements (FRAs)	p. 628
The option-adjusted spread (OAS)	p. 631
The Black model	p. 634
Applications of the Black model	p. 636
Forward put-call parity	p. 647
Caps, floors, and collars	p. 651
Conclusion	p. 656
Exercises	p. 656
Notes	p. 658
The swaps market: an introduction	p. 659
Overview	p. 659
Swaps	p. 659
The swaps market	p. 660
Plain vanilla swaps	p. 662
Motivations for swaps	p. 668
Swap facilitators	p. 673
Pricing of swaps	p. 676
Swap portfolios	p. 679
Beyond plain vanilla swaps	p. 683
Commodity swaps	p. 687
Equity swaps	p. 689
Credit swaps	p. 690
Swaptions	p. 692
Conclusion	p. 696
Exercises	p. 696
Notes	p. 698
Swaps: economic analysis and pricing	p. 700
Overview	p. 700
The economic analysis of swaps	p. 700
Interest rate swap pricing	p. 723
Currency swap pricing	p. 729
Swap counterparty credit risk	p. 734
Conclusion	p. 735
Exercises	p. 735
Notes	p. 740
Swaps: applications	p. 741
Overview	p. 741
The parallel loan-how swaps began	p. 741
Creating synthetic securities with swaps	p. 743
The all-in cost	p. 746
The B. F. Goodrich - Rabobank interest rate swap	p. 748
The duration of interest rate swaps	p. 752
Interest rate immunization with swaps	p. 753
Structured notes	p. 760
Pricing flavored interest rate and currency swaps	p. 772
Equity swap pricing and applications	p. 782
Swaption pricing and applications	p. 795
Day count conventions	p. 798
Conclusion	p. 798
Exercises	p. 798
Notes	p. 805
A summary of accounting rules for derivative instruments	p. 806
The cumulative distribution function for the standard normal random variable	p. 811
Index	p. 812
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