Options, Futures, and Other Derivatives with Derivagem CD

by Hull, John C.

• ISBN13: 9780131499089
• ISBN10: 0131499084
• Edition: 6th
• Format: Hardcover w/CD
• Copyright: 2009-01-01
• Publisher: Pearson College Div

Summary

Designed to bridge the gap between theory and practice, this successful book is regarded as "the bible" in trading rooms throughout the world.The books covers both derivatives markets and risk management, including credit risk and credit derivatives; forward, futures, and swaps; insurance, weather, and energy derivatives; and more.For options traders, options analysts, risk managers, swaps traders, financial engineers, and corporate treasurers.

Table of Contents

List of Business Snapshots	xvi
List of Technical Notes	xvii
Preface	xix
Introduction	1	(20)
Exchange-traded markets	1	(1)
Over-the-counter markets	2	(1)
Forward contracts	3	(3)
Futures contracts	6	(1)
Options	6	(2)
Types of traders	8	(1)
Hedgers	9	(2)
Speculators	11	(3)
Arbitrageurs	14	(1)
Dangers	15	(6)
Summary	15	(1)
Further reading	16	(1)
Questions and problems	16	(2)
Assignment questions	18	(3)
Mechanics of futures markets	21	(26)
Background	21	(2)
Specification of a futures contract	23	(3)
Convergence of futures price to spot price	26	(1)
Daily settlement and margins	26	(5)
Newspaper quotes	31	(4)
Delivery	35	(1)
Types of traders and types of orders	36	(1)
Regulation	37	(2)
Accounting and tax	39	(1)
Forward vs. futures contracts	40	(7)
Summary	41	(1)
Further reading	42	(1)
Questions and problems	43	(1)
Assignment questions	44	(3)
Hedging strategies using futures	47	(28)
Basic principles	47	(3)
Arguments for and against hedging	50	(3)
Basis risk	53	(3)
Cross hedging	56	(4)
Stock index futures	60	(7)
Rolling the hedge forward	67	(8)
Summary	68	(1)
Further reading	69	(1)
Questions and problems	70	(1)
Assignment questions	71	(2)
Appendix: Proof of the minimum variance hedge ratio formula	73	(2)
Interest rates	75	(24)
Types of rates	75	(2)
Measuring interest rates	77	(3)
Zero rates	80	(1)
Bond pricing	80	(2)
Determining Treasury zero rates	82	(2)
Forward rates	84	(3)
Forward rate agreements	87	(2)
Duration	89	(3)
Convexity	92	(1)
Theories of the term structure of interest rates	93	(6)
Summary	94	(1)
Further reading	95	(1)
Questions and problems	95	(2)
Assignment questions	97	(2)
Determination of forward and futures prices	99	(30)
Investment assets vs. consumption assets	99	(1)
Short selling	99	(2)
Assumptions and notation	101	(1)
Forward price for an investment asset	101	(3)
Known income	104	(3)
Known yield	107	(1)
Valuing forward contracts	107	(2)
Are forward prices and futures prices equal?	109	(1)
Futures prices of stock indices	110	(2)
Forward and futures contracts on currencies	112	(4)
Futures on commodities	116	(2)
The cost of carry	118	(1)
Delivery options	119	(1)
Futures prices and expected future spot prices	119	(10)
Summary	121	(1)
Further reading	122	(1)
Questions and problems	123	(2)
Assignment questions	125	(2)
Appendix: Proof that forward and futures prices are equal when interest rates are constant	127	(2)
Interest rate futures	129	(20)
Day count conventions	129	(2)
Quotations for Treasury bonds	131	(2)
Treasury bond futures	133	(4)
Eurodollar futures	137	(5)
Duration-based hedging strategies	142	(1)
Hedging portfolios of assets and liabilities	143	(6)
Summary	144	(1)
Further reading	145	(1)
Questions and problems	145	(2)
Assignment questions	147	(2)
Swaps	149	(32)
Mechanics of interest rate swaps	149	(6)
Day count issues	155	(1)
Confirmations	156	(1)
The comparative-advantage argument	157	(3)
The nature of swap rates	160	(1)
Determining the LIBOR/swap zero rates	160	(1)
Valuation of interest rate swaps	161	(4)
Currency swaps	165	(3)
Valuation of currency swaps	168	(3)
Credit risk	171	(2)
Other types of swaps	173	(8)
Summary	175	(1)
Further reading	176	(1)
Questions and problems	176	(2)
Assignment questions	178	(3)
Mechanics of options markets	181	(24)
Types of options	181	(2)
Option positions	183	(2)
Underlying assets	185	(2)
Specification of stock options	187	(3)
Newspaper quotes	190	(2)
Trading	192	(1)
Commissions	192	(2)
Margins	194	(1)
The options clearing corporation	195	(1)
Regulation	196	(1)
Taxation	196	(1)
Warrants, executive stock options, and convertibles	197	(1)
Over-the-counter markets	198	(7)
Summary	200	(1)
Further reading	200	(1)
Questions and problems	201	(1)
Assignment questions	202	(3)
Properties of stock options	205	(18)
Factors affecting option prices	205	(4)
Assumptions and notation	209	(1)
Upper and lower bounds for option prices	209	(3)
Put--call parity	212	(3)
Early exercise: calls on a non-dividend-paying stock	215	(1)
Early exercise: puts on a non-dividend-paying stock	216	(2)
Effect of dividends	218	(5)
Summary	219	(1)
Further reading	220	(1)
Questions and problems	220	(2)
Assignment questions	222	(1)
Trading strategies involving options	223	(18)
Strategies involving a single option and a stock	223	(2)
Spreads	225	(9)
Combinations	234	(3)
Other payoffs	237	(4)
Summary	237	(1)
Further reading	238	(1)
Questions and problems	238	(1)
Assignment questions	239	(2)
Binomial trees	241	(22)
One-step binomial model	241	(3)
Risk-neutral valuation	244	(3)
Two-step binomial trees	247	(2)
A put example	249	(1)
American options	250	(1)
Delta	251	(1)
Matching volatility with u and d	252	(3)
Increasing the number of steps	255	(1)
Options on other assets	256	(7)
Summary	260	(1)
Further reading	260	(1)
Questions and problems	261	(1)
Assignment questions	262	(1)
Wiener processes and Ito's lemma	263	(18)
The Markov property	263	(1)
Continuous-time stochastic processes	264	(5)
The process for a stock price	269	(3)
The parameters	272	(1)
Ito's lemma	273	(1)
The lognormal property	274	(7)
Summary	275	(1)
Further reading	276	(1)
Questions and problems	276	(1)
Assignment questions	277	(2)
Appendix: Derivation of Ito's lemma	279	(2)
The Black--Scholes--Merton model	281	(32)
Lognormal property of stock prices	281	(2)
The distribution of the rate of return	283	(1)
The expected return	284	(2)
Volatility	286	(3)
Concepts underlying the Black--Scholes--Merton differential equation	289	(2)
Derivation of the Black--Scholes--Merton differential equation	291	(2)
Risk-neutral valuation	293	(2)
Black--Scholes pricing formulas	295	(2)
Cumulative normal distribution function	297	(1)
Warrants and executive stock options	298	(2)
Implied volatilities	300	(1)
Dividends	301	(12)
Summary	304	(1)
Further reading	305	(1)
Questions and problems	306	(3)
Assignment questions	309	(1)
Appendix: Proof of Black--Scholes--Merton formula	310	(3)
Options on stock indices, currencies, and futures	313	(28)
Results for a stock paying a known dividend yield	313	(1)
Option pricing formulas	314	(2)
Options on stock indices	316	(5)
Currency options	321	(2)
Futures options	323	(6)
Valuation of futures options using binomial trees	329	(2)
The drift of futures prices in a risk-neutral world	331	(1)
Black's model for valuing futures options	332	(1)
Futures options vs. spot options	333	(8)
Summary	334	(1)
Further reading	335	(1)
Questions and problems	336	(3)
Assignment questions	339	(2)
The Greek letters	341	(34)
Illustration	341	(1)
Naked and covered positions	342	(1)
A stop-loss strategy	342	(2)
Delta hedging	344	(9)
Theta	353	(2)
Gamma	355	(4)
Relationship between delta, theta, and gamma	359	(1)
Vega	359	(3)
Rho	362	(1)
The realities of hedging	363	(1)
Scenario analysis	364	(1)
Portfolio insurance	364	(3)
Stock market volatility	367	(8)
Summary	368	(1)
Further reading	369	(1)
Questions and problems	369	(2)
Assignment questions	371	(2)
Appendix: Taylor series expansions and hedge parameters	373	(2)
Volatility smiles	375	(16)
Put--call parity revisited	375	(1)
Foreign currency options	376	(3)
Equity options	379	(2)
The volatility term structure and volatility surfaces	381	(2)
Greek letters	383	(1)
When a single large jump is anticipated	383	(8)
Summary	385	(1)
Further reading	386	(1)
Questions and problems	386	(2)
Assignment questions	388	(1)
Appendix: Determining implied risk-neutral distributions from volatility smiles	389	(2)
Basic numerical procedures	391	(44)
Binomial trees	391	(7)
Using the binomial tree for options on indices, currencies, and futures contracts	398	(3)
Binomial model for a dividend-paying stock	401	(5)
Alternative procedures for constructing trees	406	(3)
Time-dependent parameters	409	(1)
Monte Carlo simulation	410	(7)
Variance reduction procedures	417	(2)
Finite difference methods	419	(16)
Summary	430	(1)
Further reading	430	(1)
Questions and problems	431	(1)
Assignment questions	432	(3)
Value at risk	435	(26)
The VaR measure	435	(3)
Historical simulation	438	(2)
Model-building approach	440	(2)
Linear model	442	(4)
Quadratic model	446	(2)
Monte Carlo simulation	448	(1)
Comparison of approaches	449	(1)
Stress testing and back testing	450	(1)
Principal components analysis	450	(11)
Summary	454	(1)
Further reading	454	(1)
Questions and problems	455	(1)
Assignment questions	456	(2)
Appendix: Cash-flow mapping	458	(3)
Estimating volatilities and correlations	461	(20)
Estimating volatility	461	(2)
The exponentially weighted moving average model	463	(2)
The GARCH (1, 1) model	465	(1)
Choosing between the models	466	(1)
Maximum likelihood methods	467	(4)
Using GARCH (1,1) to forecast future volatility	471	(4)
Correlations	475	(6)
Summary	477	(1)
Further reading	478	(1)
Questions and problems	478	(2)
Assignment questions	480	(1)
Credit risk	481	(26)
Credit ratings	481	(1)
Historical default probabilities	482	(1)
Recovery rates	483	(1)
Estimating default probabilities from bond prices	484	(2)
Comparison of default probability estimates	486	(3)
Using equity prices to estimate default probabilities	489	(2)
Credit risk in derivatives transactions	491	(2)
Credit risk mitigation	493	(2)
Default correlation	495	(4)
Credit VaR	499	(8)
Summary	502	(1)
Further reading	503	(1)
Questions and problems	503	(2)
Assignment questions	505	(2)
Credit derivatives	507	(22)
Credit default swaps	507	(3)
Credit indices	510	(1)
Valuation of credit default swaps	510	(4)
CDS forwards and options	514	(1)
Total return swaps	515	(1)
Basket credit default swaps	516	(1)
Collateralized debt obligations	516	(3)
Valuation of a basket CDS and CDO	519	(1)
Convertible bonds	520	(9)
Summary	523	(1)
Further reading	524	(1)
Questions and problems	524	(2)
Assignment questions	526	(3)
Exotic options	529	(22)
Packages	529	(1)
Nonstandard American options	530	(1)
Forward start options	531	(1)
Compound options	531	(1)
Chooser options	532	(1)
Barrier options	533	(2)
Binary options	535	(1)
Lookback options	536	(1)
Shout options	537	(1)
Asian options	538	(2)
Options to exchange one asset for another	540	(1)
Options involving several assets	541	(1)
Static options replication	541	(10)
Summary	544	(1)
Further reading	544	(1)
Questions and problems	545	(2)
Assignment questions	547	(2)
Appendix: Calculation of moments for valuation of basket options and Asian options	549	(2)
Weather, energy, and insurance derivatives	551	(10)
Review of pricing issues	551	(1)
Weather derivatives	552	(1)
Energy derivatives	553	(3)
Insurance derivatives	556	(5)
Summary	557	(1)
Further reading	558	(1)
Questions and problems	558	(1)
Assignment question	559	(2)
More on models and numerical procedures	561	(28)
Alternatives to Black--Scholes	562	(4)
Stochastic volatility models	566	(2)
The IVF model	568	(1)
Path-dependent derivatives	569	(4)
Barrier options	573	(3)
Options on two correlated assets	576	(3)
Monte Carlo simulation and American options	579	(10)
Summary	583	(1)
Further reading	584	(1)
Questions and problems	585	(1)
Assignment questions	586	(3)
Martingales and measures	589	(22)
The market price of risk	590	(3)
Several state variables	593	(1)
Martingales	594	(2)
Alternative choices for the numeraire	596	(3)
Extension to several factors	599	(1)
Applications	600	(2)
Change of numeraire	602	(9)
Summary	603	(1)
Further reading	604	(1)
Questions and problems	604	(2)
Assignment questions	606	(1)
Appendix: Handling multiple sources of uncertainty	607	(4)
Interest rate derivatives: the standard market models	611	(24)
Black's model	611	(3)
Bond options	614	(5)
Interest rate caps and floors	619	(6)
European swap options	625	(4)
Generalizations	629	(1)
Hedging interest rate derivatives	630	(5)
Summary	630	(1)
Further reading	631	(1)
Questions and problems	631	(1)
Assignment questions	632	(3)
Convexity, timing, and quanto adjustments	635	(14)
Convexity adjustments	635	(4)
Timing adjustments	639	(2)
Quantos	641	(8)
Summary	644	(1)
Further reading	644	(1)
Questions and problems	645	(1)
Assignment questions	646	(2)
Appendix: Proof of the convexity adjustment formula	648	(1)
Interest rate derivatives: models of the short rate	649	(30)
Background	649	(1)
Equilibrium models	650	(4)
No-arbitrage models	654	(4)
Options on bonds	658	(1)
Volatility structures	659	(1)
Interest rate trees	660	(2)
A general tree-building procedure	662	(10)
Calibration	672	(1)
Hedging using a one-factor model	673	(6)
Summary	673	(1)
Further reading	674	(1)
Questions and problems	674	(2)
Assignment questions	676	(3)
Interest rate derivatives: HJM and LMM	679	(18)
The Health, Jarrow, and Morton model	679	(3)
The LIBOR market model	682	(10)
Mortgage-backed securities	692	(5)
Summary	694	(1)
Further reading	695	(1)
Questions and problems	696	(1)
Assignment questions	696	(1)
Swaps Revisited	697	(16)
Variations on the vanilla deal	697	(2)
Compounding swaps	699	(1)
Currency swaps	700	(1)
More complex swaps	701	(3)
Equity swaps	704	(1)
Swaps with embedded options	705	(3)
Other swaps	708	(5)
Summary	709	(1)
Further reading	710	(1)
Questions and problems	710	(1)
Assignment questions	711	(2)
Real options	713	(16)
Capital investment appraisal	713	(1)
Extension of the risk-neutral valuation framework	714	(2)
Estimating the market price of risk	716	(1)
Application to the valuation of a business	717	(1)
Commodity prices	717	(5)
Evaluating options in an investment opportunity	722	(7)
Summary	727	(1)
Further reading	727	(1)
Questions and problems	727	(1)
Assignment questions	728	(1)
Derivatives mishaps and what we can learn from them	729	(12)
Lessons for all users of derivatives	729	(4)
Lessons for financial institutions	733	(4)
Lessons for nonfinancial corporations	737	(4)
Summary	738	(1)
Further reading	738	(3)
Glossary of terms	741	(20)
DerivaGem software	761	(6)
Major exchanges trading futures and options	767	(1)
Table for N(x) when x ≤ 0	768	(1)
Table for N(x) when x > 0	769	(2)
Author index	771	(4)
Subject index	775