Derivatives Demystified: A Step-by-Step Guide to Forwards, Futures, Swaps and Options

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John Wiley & Sons, Sep 19, 2011 - Business & Economics - 288 pages
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Derivatives are everywhere in the modern world and it is important for everyone in banking, investment and finance to have a good understanding of the subject. Derivatives Demystified provides a step-by-step guide to the subject, enabling the reader to have a solid, working understanding of key derivative products.

Adopting a highly accessible approach, the author explains derivative products in straightforward terms and without the complex mathematics that underlie the subject, focusing on practical applications, case studies and examples of how the products are used to solve real-world problems. Derivatives Demystified follows a sequence that is designed to show that, although there are many applications of derivatives, there are only a small number of basic building blocks, namely forwards and futures, swaps and options. The book shows how each building block is applied to different markets and to the solution of various risk management and trading problems.

This new edition will be fully revised to reflect the many changes the derivatives markets have seen over the last three years.  New material will include a comprehensive history of derivatives, leading up to their use and abuse in the current credit crisis.  It will also feature new chapters on regulation and control of derivatives, commodity derivatives, credit derivatives and structured products and new derivative markets including inflation linked and insurance linked products. 

Derivatives Demystified is essential reading for everyone who operates in the financial markets or within the corporate environment who requires a good understanding of these important financial instruments.

 

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Contents

INTEREST RATE CAP
INTEREST RATE COLLAR
INTEREST RATE SWAP AND SWAPTION
SUMMARY OF INTEREST RATE HEDGING STRATEGIES
EURODOLLAR OPTIONS
EURO AND STERLING INTEREST RATE OPTIONS
BOND OPTIONS
EXCHANGETRADED BOND OPTIONS

THE WILD BEAST OF FINANCE?
LESSONS FROM RECENT HISTORY
CREATIVE DESTRUCTION AND CONTAGION EFFECTS
THE MODERN OTC DERIVATIVES MARKET
THE EXCHANGETRADED DERIVATIVES MARKET
CHAPTER SUMMARY
INTRODUCTION
THE FORWARD PRICE
THE FORWARD PRICE AND ARBITRAGE OPPORTUNITIES
THE FORWARD PRICE AND THE EXPECTED PAYOUT
FOREIGN EXCHANGE FORWARDS
MANAGING CURRENCY RISK
HEDGING WITH AN OUTRIGHT FORWARD FX DEAL
THE FORWARD FOREIGN EXCHANGE RATE
THE FORWARD FX RATE AND ARBITRAGE OPPORTUNITIES
FORWARD POINTS
FX SWAPS
APPLICATIONS OF FX SWAPS
INTRODUCTION
CORPORATE BORROWER
RESULTS OF THE FRA HEDGE
THE FRA AS TWO PAYMENT LEGS
DEALING IN FRAs
FORWARD INTEREST RATES
CHAPTER SUMMARY
INTRODUCTION
THE MARGINING SYSTEM AND THE CLEARING HOUSE
USERS OF FUTURES CONTRACTS
COMMODITY FUTURES
FUTURES PRICES AND THE BASIS
US TREASURY BOND FUTURES
DELIVERY PROCEDURES
GILT FUTURES
CHAPTER SUMMARY
INTRODUCTION
EURODOLLAR FUTURES
TRADING EURODOLLAR FUTURES
HEDGING WITH INTEREST RATE FUTURES
INTEREST RATE FUTURES PRICES
EQUITY INDEX FUTURES
APPLICATIONS OF SP 500 INDEX FUTURES
FTSE 100 INDEX FUTURES CONTRACTS
ESTABLISHING NET PROFITS AND LOSSES
SINGLE STOCK FUTURES SSFs
CHAPTER SUMMARY
INTRODUCTION
INTEREST RATE SWAP STRUCTURE
BASIC SINGLECURRENCY INTEREST RATE SWAP
THE SWAP AS A PACKAGE OF SPOT AND FORWARD DEALS
RATIONALE FOR THE SWAP DEAL
TYPICAL SWAP APPLICATIONS
INTEREST RATE SWAP VARIANTS
CROSSCURRENCY INTEREST RATE SWAPS
NET BORROWING COSTS USING A CROSSCURRENCY SWAP
INFLATION SWAPS
CHAPTER SUMMARY
INTRODUCTION TO EQUITY SWAPS
EQUITY SWAP CASE STUDY
OTHER APPLICATIONS OF EQUITY SWAPS
EQUITY INDEX SWAPS
HEDGING AN EQUITY INDEX SWAP
CREDIT DEFAULT SWAPS
BASIC STRUCTURE
CREDIT DEFAULT SWAP APPLICATIONS
CREDIT SPREADS
THE CDS PREMIUM AND THE CREDIT SPREAD
PRICING MODELS FOR CDS PREMIUM
INDEX CREDIT DEFAULT SWAPS
BASKET CREDIT DEFAULT SWAPS
CHAPTER SUMMARY
INTRODUCTION
TYPES OF OPTIONS
BASIC OPTION TRADING STRATEGIES
EXPIRY PAYOFF PROFILE
EXPIRY PAYOFF PROFILE
EXPIRY PAYOFF PROFILE
EXPIRY PAYOFF PROFILE
CHAPTER OVERVIEW
PROTECTIVE PUT
HEDGING WITH ATM PUT OPTION
COVERED CALL WRITING
EQUITY COLLAR
ZEROCOST EQUITY COLLAR
PROTECTIVE PUT WITH A BARRIER OPTION
BEHAVIOUR OF BARRIER OPTIONS
CHAPTER SUMMARY
INTRODUCTION
CBOE STOCK OPTIONS
UK STOCK OPTIONS ON NYSE LIFFE
CME SP 500 INDEX OPTIONS
FTSE 100 INDEX OPTIONS
CHAPTER SUMMARY
INTRODUCTION
USERS OF CURRENCY OPTIONS
CASE STUDY
GRAPH OF HEDGED AND UNHEDGED POSITIONS
HEDGING WITH A ZEROCOST COLLAR
REDUCING PREMIUM ON FX HEDGES
COMPOUND OPTIONS
EXCHANGETRADED CURRENCY OPTIONS
CHAPTER SUMMARY
INTRODUCTION
OTC INTEREST RATE OPTION CASE STUDY
HEDGING A LOAN WITH A CAPLET
CHAPTER SUMMARY
INTRODUCTION
THE CONCEPT OF A RISKLESS HEDGE
A SIMPLE OPTION PRICING MODEL
OPTION FAIR VALUE
EXTENDING THE BINOMIAL MODEL
COST OF DYNAMIC HEDGING
THE BLACKSCHOLES OPTION PRICING MODEL
HISTORICAL VOLATILITY
MEASURING AND USING HISTORICAL VOLATILITY
CHAPTER SUMMARY
INTRODUCTION
IMPLIED VOLATILITY
BLACKSCHOLES MODEL ASSUMPTIONS
VALUE OF A CALL OPTION
VALUE OF A PUT OPTION
EQUITY INDEX AND CURRENCY OPTIONS
PRICING INTEREST RATE OPTIONS
CHAPTER SUMMARY
INTRODUCTION
DELTA BEHAVIOUR
DELTA AS THE HEDGE RATIO
THE EFFECTS OF CHANGES IN DELTA
READJUSTING THE DELTA HEDGE
GAMMA ΓORγ
GAMMA AND THE SPOT PRICE OF THE UNDERLYING
GAMMA AND TIME TO EXPIRY
THETA Θ
VEGA OR KAPPA κ
RHO p
SUMMARY OF GREEKS
CHAPTER SUMMARY
INTRODUCTION
BULL SPREAD
BULL POSITION WITH DIGITAL OPTIONS
SPOT PRICE AND CON VALUE
BEAR SPREAD
THE GREEKS FOR THE BEAR SPREAD
PUT OR BEAR RATIO SPREAD
LONG STRADDLE
LONG STRADDLE CURRENT PAYOFF PROFILE
POTENTIAL RISKS WITH A LONG STRADDLE
CHAPTER SUMMARY
INTRODUCTION
SHORT STRADDLE
POTENTIAL PROFITS WITH A SHORT STRADDLE
MANAGING THE RISK ON A SHORT STRADDLE
SHORT STRANGLE
NEW WAYS OF TRADING VOLATILITY
CALENDAR OR TIME SPREAD
CHAPTER SUMMARY
INTRODUCTION
ISSUERS OF CONVERTIBLE BONDS
CB MEASURES OF VALUE
CONVERSION PREMIUM AND PARITY
OTHER FACTORS AFFECTING CB VALUE
CONVERTIBLE ARBITRAGE
CONVERTIBLE ARBITRAGE EXAMPLE
PROFITS AND RISKS WITH THE CB ARBITRAGE TRADE
MANDATORILY CONVERTIBLES AND EXCHANGEABLES
STRUCTURING A MANDATORILY EXCHANGEABLE ME BOND
CHAPTER SUMMARY
INTRODUCTION
CAPITAL PROTECTION EQUITYLINKED NOTES
EXPIRY VALUE OF 100 CAPITAL PROTECTION NOTES
100 PARTICIPATION EQUITYLINKED NOTES
CAPPED PARTICIPATION EQUITYLINKED NOTES
AVERAGE PRICE NOTES
CLIQUET OPTIONS
SECURITIZATION AND CDOs
THE BASIC CDO STRUCTURE
RATIONALE FOR SECURITIZATION
SYNTHETIC CDOs
CHAPTER SUMMARY
INTRODUCTION
SETTLEMENT OF EXCHANGETRADED DERIVATIVES
MAJOR CLEARING HOUSES
CONFIRMATION AND SETTLEMENT OF OTC DEALS
CONTROLLING COUNTERPARTY RISK ON OTC DERIVATIVES
OPERATIONAL RISK
BEST PRACTICE IN OPERATIONAL RISK MANAGEMENT
CHAPTER SUMMARY
TIME VALUE OF MONEY
FUTURE VALUE FV WITH PERIODIC COMPOUNDING
ANNUAL EQUIVALENT RATE AER
PRESENT VALUE PV WITH PERIODIC COMPOUNDING
CONTINUOUSLY COMPOUNDED INTEREST RATES
YIELD OR RETURN ON INVESTMENT
TERM STRUCTURE OF INTEREST RATES
CALCULATING FORWARD INTEREST RATES
FORWARD RATES AND FRAs
DISCOUNT FACTORS DFs
PRICING A SWAP FROM THE TERM STRUCTURE
CALCULATING THE BINOMIAL VALUES
BLACKSCHOLES MODEL
BLACKSCHOLES EXAMPLE
MEASURING HISTORIC VOLATILITY
Asian or average price options
Bermudan options
Chooser preference options
Forwardstart options
Lookback options
Quanto option
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About the author (2011)

Andrew Chisholm, (London, UK) is an independent consultant providing derivatives and capital markets training services to the investment banking industry.  He has taught finance for major investment banks and portfolio management firms around the world since 1986 and was formerly head of training for JP Morgan in Europe. He was co-founder of Chisholm Roth and Company Ltd., a specialist in computer simulation-based training for traders, investors and risk managers in the capital markets industry. Andrew was educated at Edinburgh and Oxford Universities and Dartmouth College in the US and also has an MBA from the Warwick University Business School.

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