Principles of Financial Engineering (Google eBook)

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Academic Press, Dec 9, 2008 - Business & Economics - 696 pages
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Five new chapters, numerous additions to existing chapters, and an expanded collection of questions and exercises make this Second Edition an essential part of everyone's library. Between defining swaps on its first page and presenting a case study on its last, Salih Neftci's introduction to financial engineering shows readers how to create financial assets in static and dynamic environments. Poised among intuition, actual events, and financial mathematics, this book can be used to solve problems in risk management, taxation, regulation, and above all, pricing.

* The Second Edition presents 5 new chapters on structured product engineering, credit markets and instruments, and principle protection techniques, among other topics
* Additions, clarifications, and illustrations throughout the volume show these instruments at work instead of explaining how they should act
* The Solutions Manual enhances the text by presenting additional cases and solutions to exercises
  

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Contents

FixedIncome Engineering
373
2 A Framework for Swaps
374
3 Term Structure Modeling
383
4 Term Structure Dynamics
385
5 Measure Change Technology
394
6 An Application
399
7 InArrears Swaps and Convexity
404
8 CrossCurrency Swaps
408

An Introduction to Some Concepts and Definitions
23
3 Players
27
5 Market Conventions
30
6 Instruments
37
8 The Syndication Process
41
Suggested Reading
42
Exercises
46
Cash Flow Engineering and Forward Contracts
47
3 Forward Contracts
51
4 Currency Forwards
54
5 Synthetics and Pricing
59
7 Applications
60
8 A BetterSynthetic
66
9 Futures
70
10 Conventions for Forwards
75
11 Conclusions
76
Suggested Reading
77
Exercises
78
HKMA and the Hedge Funds 1998
80
Engineering Simple Interest Rate Derivatives
83
2 Libor and Other Benchmarks
84
3 Forward Loans
85
4 Forward Rate Agreements
92
Eurocurrency Contracts
96
6 RealWorld Complications
100
7 Forward Rates and Term Structure
102
8 Conventions
103
Strips
104
10 Conclusions
105
Exercises
106
Introduction to Swap Engineering
109
2 Applications
112
Swaps
117
4 Types of Swaps
120
5 Engineering Interest Rate Swaps
129
6 Uses of Swaps
137
7 Mechanics of Swapping New Issues
142
8 Some Conventions
148
10 Additional Terminology
150
11 Conclusions
151
Exercises
152
Repo Market Strategies in Financial Engineering
157
2 What Is Repo?
158
3 Types of Repo
160
4 Equity Repos
165
6 Synthetics Using Repos
171
7 Conclusions
173
Exercises
174
CTD and Repo Arbitrage
175
Dynamic Replication Methods and Synthetics
177
2 An Example
178
4 Ad HocSynthetics
183
5 Principles of Dynamic Replication
186
6 Some Important Conditions
197
7 RealLife Complications
198
8 Conclusions
200
Exercises
201
Mechanics of Options
203
2 What Is an Option?
204
Definition and Notation
205
4 Options as Volatility Instruments
211
5 Tools for Options
221
6 The Greeks and Their Uses
228
7 RealLife Complications
240
What Is an Option?
241
APPENDIX 81
242
APPENDIX 82
244
Exercises
246
Engineering Convexity Positions
249
2 A Puzzle
250
4 Sources of Convexity
262
Quantos
267
6 Conclusions
272
Exercises
273
Convexity of Long Bonds Swaps and Arbitrage
275
Options Engineering with Applications
277
2 Option Strategies
280
3 VolatilityBased Strategies
291
4 Exotics
296
5 Quoting Conventions
307
6 RealWorld Complications
309
7 Conclusions
310
Exercises
311
Pricing Tools in Financial Engineering
315
2 Summary of Pricing Approaches
316
3 The Framework
317
4 An Application
322
5 Implications of the Fundamental Theorem
328
6 ArbitrageFree Dynamics
334
7 Which Pricing Method to Choose?
338
8 Conclusions
339
Simple Economics of the Fundamental Theorem
340
Exercises
342
Some Applications of the Fundamental Theorem
345
The Monte Carlo Approach
346
Calibration
354
Quantos
363
5 Conclusions
370
Exercises
371
9 Differential Quanto Swaps
409
Suggested Reading
410
Practical Yield Curve Calculations
411
Exercises
414
Tools for Volatility Engineering Volatility Swaps and Volatility Trading
415
2 Volatility Positions
416
3 Invariance of Volatility Payoffs
417
4 Pure Volatility Positions
424
5 Volatility Swaps
427
6 Some Uses of the Contract
432
7 Which Volatility?
433
8 Conclusions
434
Suggested Reading
435
Exercises
436
Volatility as an Asset Class and the Smile
439
2 Volatility as Funding
440
3 Smile
442
5 Application to Option Payoffs
444
6 BreedenLitzenberger Simplified
446
7 A Characterization of Option Prices as Gamma Gains
450
8 Introduction to the Smile
451
9 Preliminaries
452
10 A First Look at the Smile
453
11 What Is the Volatility Smile?
454
13 How to Explain the Smile
462
14 The Relevance of the Smile
469
15 Trading the Smile
470
17 Exotic Options and the Smile
471
18 Conclusions
475
Exercises
476
Credit Markets CDS Engineering
479
2 Terminology and Definitions
480
3 Credit Default Swaps
482
4 RealWorld Complications
492
5 CDS Analytics
494
6 Default Probability Arithmetic
495
7 Structured Credit Products
500
8 Total Return Swaps
504
9 Conclusions
505
Exercises
507
CreditLinked Notes
510
Essentials of Structured Product Engineering
513
2 Purposes of Structured Products
514
3 Structured FixedIncome Products
526
4 Some Prototypes
533
5 Conclusions
543
Suggested Reading
544
Exercises
545
Credit Indices and Their Tranches
547
3 Introduction to ABS and CDO
548
4 A Setup for Credit Indices
550
5 Index Arbitrage
553
Standard and Bespoke
555
7 Tranche Modeling and Pricing
556
8 The Roll and the Implications
560
9 Credit versus Default Loss Distributions
562
10 An Important Generalization
563
11 New Index Markets
566
12 Conclusions
568
A History of Credit Indices
569
Exercises
570
Default Correlation Pricing and Trading
571
2 Some History
572
4 The Model
575
5 Default Correlation and Trading
579
6 Delta Hedging and Correlation Trading
580
7 RealWorld Complications
585
8 Conclusions
587
Some Basic Statistical Concepts
588
Exercises
590
May 2005 Volatility
591
Principal Protection Techniques
595
2 The Classical Case
596
3 The CPPI
597
4 Modeling the CPPI Dynamics
599
CPPI and Equity Tranches
601
The DPPI
604
7 RealWorld Complications
605
8 Conclusions
606
Exercises
607
CapsFloors and Swaptions with an Application to Mortgages
611
2 The Mortgage Market
612
3 Swaptions
618
4 Pricing Swaptions
620
5 MortgageBased Securities
625
6 Caps and Floors
626
7 Conclusions
631
Exercises
632
Danish Mortgage Bonds
634
Engineering of Equity Instruments Pricing and Replication
637
2 What Is Equity?
638
3 Engineering Equity Products
644
4 Financial Engineering of Securitization
654
5 Conclusions
657
Exercises
658
Volatility Trading
659
References
663
Index
667
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