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Derivatives and Risk Management

Name: Derivatives and Risk Management
Author: Sundaram Janakiramanan
ISBN: 9788131755143

by Sundaram Janakiramanan

February 2011

Beginner to intermediate

536 pages

22h 7m

English

Pearson India

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Cover
Title Page
Contents
About the Author
Dedication
Preface
1 - Introduction
Learning Objectives1.1 - What are Derivatives?1.2 - Derivatives Markets1.3 - Forward Contracts1.4 - Futures Contracts1.5 - Options Contracts1.6 - Swap Contracts1.7 - Uses of Derivatives1.8 - What is Risk?1.8.1 - Operating or Business Risk1.8.2 - Event Risk1.8.3 - Price Risk1.9 - Risk Management1.10 - A Brief History of Risk Management1.11 - Implications for Hedging1.12 - Upside and Downside Risks1.13 - Commodity Price Risk1.13.1 - Volatility1.13.2 - Liquidity1.14 - Interest Rate Risk1.14.1 - Deregulation and Interest Rate as a Tool for Developing Monetary Policy1.14.2 - Floating Rate Loans1.14.3 - Interest Rates and Inflation1.14.4 - Components of Interest Rate Risk1.15 - Currency Risk1.16 - Approaches to Risk Management1.17 - Risks in Derivatives TradingChapter SummaryReview QuestionsProblemsCase Study
2 - The Derivatives Market in India
Learning Objectives2.1 - The International Derivatives Market2.2 - Derivatives in India2.3 - Operations of Derivatives Exchanges2.4 - The Trading System2.4.1 - Types of Orders2.4.2 - Order-matching Rules2.4.3 - Order Conditions2.5 - The Clearing and Settlement System2.5.1 - The Members of the Clearing House2.5.2 - The Clearing Mechanism2.5.3 - Margin and Margin Accounts2.5.4 - The Settlement System2.5.5 - Risk Management2.6 - The Trading Process2.7 - Online Trading2.8 - The OTC Derivatives Market2.9 - The Regulation of Derivatives Trading in IndiaChapter SummaryReview QuestionsExhibit 2.1
3 - Interest Rates
Learning Objectives3.1 - What is Interest Rate?3.2 - Simple and Compound Interest Rates3.3 - Future Value and Present Value3.3.1 - Present Value3.4 - Effective Interest Rates for Different Compounding Periods3.4.1 - Present Value for Different Compounding Periods3.4.2 - Relation between Rate under Continuous Compounding and Rate under Compounding for m Periods3.5 - Risk-free Interest Rate3.5.1 - Interest Rate Risk3.5.2 - Default Risk3.5.3 - Call Risk3.5.4 - Liquidity Risk3.6 - Risk-free Rates3.6.1 - Government Security3.6.2 - Interbank Rates3.6.3 - Repurchase Agreement Rate (Repo Rate)3.7 - Interest Rate Risk and Forward Rates3.8 - Term Structure of Interest Rates3.8.1 - Implied Forward Rates3.8.2 - Why Implied Forward Rates?3.8.3 - Calculating Implied Forward Rate from Coupon BondsChapter SummaryReview QuestionsProblemsCase Study
4 - Forward Contracts
Learning Objectives4.1 - What is a Forward Contract?4.2 - The Purpose of Forward Contracts4.3 - Advantages of Forward Contracts4.4 - Problems with Forward Contracts4.4.1 - Parties with Matching Needs4.4.2 - Non-performance4.4.3 - Non-transferability4.5 - The Pricing of Commodity Forward Contracts4.6 - Currency Forward Contracts4.6.1 - The Operation of the Currency Forward Market4.6.2 - Characteristics of Currency Forward Contracts4.6.3 - The Pricing of Currency Forward Contracts4.6.4 - Covered Interest Arbitrage4.6.5 - Rolling over Currency Forward Contracts4.7 - Interest Rate Forwards4.7.1 - Mechanics of FRAs4.7.2 - The FRA Payment Amount4.7.3 - An Alternative View of an FRA and the Settlement Amount4.7.4 - Uses of FRAs4.8 - Non-deliverable ForwardsChapter SummaryReview QuestionsProblemsCase Study

5 - Futures Contracts
Learning Objectives5.1 - What is a Futures Contract?5.2 - Futures Contracts Versus Forward Contracts5.2.1 - Negotiability5.2.2 - Standardization5.2.3 - Liquidity5.2.4 - Performance5.2.5 - Cash Needs5.2.6 - Ability to Reduce Losses5.3 - Participants in Futures Markets5.3.1 - Hedgers5.3.2 - Speculators5.3.3 - Arbitragers5.4 - Specifications of Futures Contracts5.4.1 - The Underlying Asset5.4.2 - The Contract Size5.4.3 - Delivery Arrangements: Location5.4.4 - Delivery Arrangements: Alternative Grade5.4.5 - Delivery Month5.4.6 - Delivery Notification5.4.7 - Daily Price Movement Limits5.4.8 - Position Limits5.5 - Closing out the Positions5.6 - Arbitrage between the Futures Market and the Spot Market5.7 - Performance of Contracts5.8 - The Clearinghouse5.9 - Margins and Marking-to-Market5.10 - Price Quotes5.11 - Settlement Price5.12 - Open Interest5.13 - The Pattern of Prices5.14 - The Relation between Futures Price and Spot Price5.15 - Delivery5.16 - Cash Settlement5.17 - Types of Orders5.17.1 - Market Orders5.17.2 - Limit Orders5.17.3 - Stop Orders5.17.4 - Stop–Limit Orders5.17.5 - Other Orders5.18 - How to Trade in Futures?5.19 - Pricing of Futures ContractsChapter SummaryReview QuestionsProblemsCase Study
6 - Hedging Strategies Using Futures
Learning Objectives6.1 - The Principles of Hedging6.2 - Long Hedges6.3 - Short Hedges6.4 - Should Hedging be Undertaken?6.5 - Risks in Hedging6.6 - Basis Risk6.7 - Factors Affecting Basis Risk6.8 - The Hedge Ratio6.9 - Static and Dynamic Hedging6.10 - Strip Hedges and Stack Rolling Hedges6.11 - Losses from Hedging Using FuturesChapter SummaryReview QuestionsProblemsCase Study
7 - Single Stock Futures and Stock Index Futures
Learning Objectives7.1 - Single Stock Futures7.2 - What is a Stock Futures Contract?7.3 - Hedging Using Single Stock Futures7.3.1 - What Type of Hedging is Appropriate?7.3.2 - Which Instrument to Use?7.3.3 - How Many Contracts to Use?7.3.4 - When to Take an Open Position?7.3.5 - When to Close the Position?7.3.6 - Risks in Hedging Using Single Stock Futures7.4 - Speculation Using Stock Futures7.5 - Pricing of Single Stock Futures Contracts7.6 - Single Stock Futures and Arbitrage7.7 - Using Stock Futures for Insurance Purposes7.8 - Using Stock Futures for Investment Purposes7.9 - Stock Indexes7.10 - Stock Index Futures7.11 - Stock Index Futures Contracts Traded on the BSE and the NSE7.12 - How do Index Futures Work?7.13 - Pricing of Index Futures Contracts7.14 - Speculation Using Index Futures7.15 - Portfolio Insurance Using Index Futures7.16 - Index Arbitrage7.17 - Program Trading7.18 - Hedging the Value of a Portfolio of Shares Using Index Futures7.19 - Adjusting Equity Portfolio Beta Using Index Futures7.20 - Issues in Using Index FuturesChapter SummaryReview QuestionsProblemsCase Study
8 - Interest Rate Futures
Learning Objectives8.1 - The Impact of Interest Rate Risk and the Need for Hedging8.2 - Interest Rate Futures in India8.3 - Contract Specification8.4 - Conversion Factor8.5 - Cheapest-to-deliver Bonds8.6 - The Pricing of Bond Futures8.7 - Uses of Long-term Interest Rate Futures8.7.1 - Directional Trading8.7.2 - Arbitrage8.7.3 - Calendar-spread Trading8.7.4 - Hedging8.7.5 - Fixed Income Portfolio Management8.7.6 - Changing a Fixed Income Loan to a Floating-rate Loan8.8 - Short-term Interest Rate Futures8.9 - Pricing of T-bill Futures Contracts8.10 - Hedging Using Bill Futures Contracts8.11 - Uses of Short-term Interest Rate Futures Contracts8.11.1 - Hedging Borrowing Costs8.11.2 - Hedging an Investment Yield8.11.3 - Hedging a Floating-rate Loan or Strip Hedging8.11.4 - Directional Trades8.11.5 - Spread Trades8.11.6 - Arbitrage Transactions8.11.7 - Adjusting the Duration of the Portfolio8.11.8 - Cross-hedging8.12 - Cautions in Using Interest Rate FuturesChapter SummaryReview QuestionsProblemsCase Study
9 - Currency Futures
Learning Objectives9.1 - What are Currency Futures?9.2 - The Specifications of Exchange-traded Currency Futures Contracts9.3 - The Pricing of Currency Futures9.4 - Hedging with Currency Futures9.5 - Basis Risk While Using Currency Futures9.6 - Speculation Using Currency Futures9.7 - Arbitraging with Currency Futures ContractsChapter SummaryReview QuestionsProblemsCase Study
10 - Swaps
Learning Objectives10.1 - What are Swaps?10.2 - Types of Swaps10.3 - Terminologies in Swaps10.4 - Interest Rate Swaps10.5 - Swap Rates10.6 - Rationale for Swap Arrangements10.7 - Swap with Intermediaries10.8 - Forward Swaps10.9 - Swaptions10.10 - Uses of Interest Rate Swaps10.11 - Valuation of Interest Rate Swaps10.12 - Currency Swaps10.12.1 - Differences between an Interest Rate Swap and a Currency Swap10.12.2 - Basic Structure of Currency Swaps10.13 - Currency Risk in Currency Swaps10.14 - Comparative Advantages of Currency Swaps10.15 - Uses of Currency Swaps10.16 - The Valuation of a Currency Swap10.17 - Equity Swaps10.18 - The Valuation of an Equity Swap10.19 - Commodity Swaps10.20 - Risks While Entering into Interest Rate SwapsChapter SummaryReview QuestionsProblemsCase Study
11 - Fundamentals of Options
Learning Objectives11.1 - Options Issued by Corporations11.1.1 - Warrants11.1.2 - Employee Stock Options11.1.3 - Convertible Bonds11.1.4 - Callable Bonds11.1.5 - Put Bonds11.1.6 - Rights11.2 - Options Contracts between Private Parties11.3 - Exchange-traded Options11.4 - Options Contracts: An Example11.5 - What is an Options Contract?11.6 - Options Terminologies11.6.1 - The Underlying Asset11.6.2 - Call and Put Options11.6.3 - The Option Premium11.6.4 - Exercising Options11.6.5 - The Exercise Price or the Strike Price11.6.6 - The Exercise Date or the Strike Date11.6.7 - American and European Options11.6.8 - Buyers and Writers of Options11.6.9 - The Contract Size11.6.10 - In-the-money, At-the-money and Out-of-money Options11.7 - Exchange-traded and OTC Options: A Comparison11.7.1 - Guarantee of Performance in Exchange-traded Options11.7.2 - Margin Requirements11.7.3 - Margin Calculation11.7.4 - Standardization of Contracts11.7.5 - Exercise Dates11.7.6 - Exercise Prices11.7.7 - Options Classes and Options Series11.8 - Trading of Options11.8.1 - Types of Orders11.8.2 - Offsetting Orders11.9 - Price Quotes11.10 - Protection Against Corporate ActionsChapter SummaryReview QuestionsProblemsCase Study
12 - Call and Put Options
Learning Objectives12.1 - What are Call Options?12.2 - The Terminal Value of a Call Option12.3 - Gains and Losses from Purchasing Call Options12.4 - Value of a Call Option Before Maturity12.5 - Minimum and Maximum Values of a Call12.6 - When to Exercise an American Call Option12.7 - From a Call Option Writer's Point of View12.7.1 - The Terminal Value of a Written Call12.7.2 - Gains and Losses for a Call Writer12.8 - Comparison between the Gains Made by a Call Buyer and a Call Writer12.9 - When to Buy and When to Write a Call Option?12.10 - Put Options12.10.1 - What are Put Options?12.10.2 - Rationale for Put Options12.11 - The Terminal Value of a Put Option12.12 - Gains and Losses from Purchasing Put Options12.13 - Value of a Put Option Before Maturity12.14 - Minimum and Maximum Values of Put12.15 - When to Exercise a Put Option12.16 - From a Put Option Writer's Point of View12.16.1 - The Terminal Value of a Written Put12.16.2 - Gains and Losses for a Put Writer12.17 - Comparison between the Gains Made by a Put Buyer and a Put Writer12.18 - When to Buy and When to Write a Put Option12.19 - Comparison between Calls and PutsChapter SummaryReview QuestionsProblemsCase Study
13 - Combinations of Options: Trading Strategies
Learning Objectives13.1 - Naked or Uncovered Positions13.1.1 - Naked Long Stock Positions13.1.2 - Naked Short Stock Positions13.1.3 - Naked Bought Calls13.1.4 - Naked Written Calls13.1.5 - Naked Bought Puts13.1.6 - Naked Written Puts13.2 - Hedge or Covered Positions13.2.1 - Covered Call Writing13.2.2 - Reverse Hedges13.2.3 - Protective Puts13.2.4 - Short Stocks and Short Puts13.2.5 - Partial Hedges13.2.6 - Summary of Hedged Positions13.3 - Spread Positions13.3.1 - Money Spread Using Calls13.3.2 - Money Spreads Using Puts13.3.3 - Box Spreads13.3.4 - Butterfly Spreads13.3.5 - Calendar Spreads13.3.6 - Iron Condor Spreads13.4 - Combinations of Puts and Calls13.4.1 - Straddles13.4.2 - Strips13.4.3 - Straps13.4.4 - Strangles13.4.5 - Other Pay-offs13.5 - Losses from Options TradingChapter SummaryReview QuestionsProblemsCase Study
14 - Put–Call Parity
Learning Objectives14.1 - Risk-free Security14.2 - Strategies Using Options, a Risk-free Security and Underlying Assets14.2.1 - Combination of Call Options and Risk-free Securities14.2.2 - Combination of Long Stocks and Long Puts14.3 - The Put–Call Relationship14.4 - Put–Call Arbitrage14.5 - Creation of Synthetic Securities14.5.1 - Creation of Synthetic Puts14.5.2 - The Written Put Strategy14.5.3 - The Bought Call Strategy14.5.4 - The Written Call Strategy14.5.5 - The Strategy of Investing at a Risk-free Rate14.5.6 - The Strategy for Borrowing at a Risk-free Rate14.5.7 - Cautions in Creating Synthetic Positions14.6 - Put–Call Parity for Dividend-paying Stocks: European Options14.7 - Put–Call Parity for American Options14.7.1 - Early Exercise of American Call Options: Non-dividend-paying Stock14.7.2 - Early Exercise of Call Options: Dividend-paying Stock14.7.3 - Early Exercise of Put Options: Non-dividend-paying Stock14.7.4 - Put–Call Parity for American Options When Dividends are Not Paid14.7.5 - Put–Call Parity for American Options When Dividends are Paid14.8 - Implications of Put–Call Parity14.9 - Put–Call Parity and Regulatory ArbitrageChapter SummaryReview QuestionsProblemsCase Study
15 - The Binomial Options Pricing Model
Learning Objectives15.1 - The Binomial Options Pricing Model for Call Options15.2 - The Binomial Options Pricing Model for Put Options15.3 - The Relation between the Hedge Ratios for Call and Put Options15.4 - The No-arbitrage Pricing Argument15.5 - The Derivation of the Binomial Options Pricing Model15.6 - The Single-period Binomial Options Pricing Model15.7 - The Two-period Binomial Options Pricing Model15.8 - The Multi-period Binomial Options Pricing Model15.9 - The Determination of u and d15.10 - The Valuation of a European Call Paying a Given Dividend Amount15.11 - The Valuation of an American Call Paying a Given Dividend Amount15.12 - The Binomial Put Options Pricing ModelChapter SummaryReview QuestionsProblemsCase Study
16 - The Black–Scholes Options Pricing Model
Learning Objectives16.1 - The History of Options Pricing Research16.2 - Stock Price Behaviour16.2.1 - Lognormal Distribution16.2.2 - The Valuation of Options16.3 - The Assumptions in the Black–Scholes Options Pricing Model16.4 - The Black–Scholes Model for Pricing Call Options16.5 - The Black–Scholes Model for Pricing Put Options16.6 - Determinants of Options Prices16.6.1 - The Current Price of the Underlying Asset16.6.2 - The Exercise Price16.6.3 - The Time to Expiration16.6.4 - Volatility of the Underlying Asset16.6.5 - The Risk-free Rate16.7 - The Options Pricing Model for Securities that Pay Known Dividends16.8 - Volatility16.9 - Implied Volatility16.10 - Volatility SmileChapter SummaryReview QuestionsProblemsCase Study
17 - Currency Options, Interest Rate Options and Options on Futures
Learning Objectives17.1 - Currency Options17.2 - Interest Rate Options17.2.1 - Bond Options17.2.2 - Embedded Bond Options17.2.3 - Interest Rate Options17.3 - Interest Rate Caps, Floors and Collars17.3.1 - Interest Rate Caps17.3.2 - Interest Rate Floors17.3.3 - Interest Rate Collars17.4 - Pricing Interest Rate Options17.5 - Valuing an Interest Rate Cap or Floor17.6 - Options on Futures or Futures Options17.6.1 - Model for Valuing Options on Futures ContractsChapter SummaryReview QuestionsProblemsCase Study
18 - Greeks in Options
Learning Objectives18.1 - Risks in Options Trading18.2 - Characteristics of Options Hedging18.2.1 - The Naked Position18.2.2 - The Covered Position18.2.3 - Hedging Through the Cap18.3 - Greeks in Options Hedging18.4 - Delta18.4.1 - The Use of Futures in Delta Hedging18.4.2 - The Delta of a Portfolio18.5 - Gamma18.5.1 - Making a Portfolio Gamma-neutral18.5.2 - Calculating Gamma18.6 - Theta18.7 - The Relationship between Delta, Gamma and Theta18.8 - Vega18.9 - Rho18.10 - Creating Portfolio Insurance Using Synthetic Puts18.11 - Hedging Options Positions in PracticeChapter SummaryReview QuestionsProblemsCase Study
19 - Exotic Options
Learning Objectives19.1 - Differences between Plain Vanilla Options and Exotic Options19.2 - Asian Options19.3 - Barrier Options19.3.1 - Down-and-out Options19.3.2 - Down-and-in Options19.3.3 - Up-and-in Barrier Options19.3.4 - Up-and-out Barrier Options19.4 - Chooser Options19.5 - Compound Options19.6 - Digital or Binary Options19.7 - Exchange Options19.8 - Basket Options19.9 - Bermudan Options19.10 - Cliquet/Ratchet Options19.11 - Coupe Options19.12 - Extendible Options19.13 - Hawaiian Options19.14 - Instalment Options19.15 - Israeli Options19.16 - Parisian Options19.17 - Passport Options19.18 - Rainbow Options19.19 - Russian Options19.20 - Shout Options19.21 - Spread Options19.22 - Quanto Options19.23 - Forward Start Options19.24 - Edokko Options or Tokyo Options19.25 - Lookback Options19.26 - Extreme Spread Options19.27 - Mountain Range OptionsChapter SummaryReview Questions
20 - Credit Derivatives
Learning Objectives20.1 - An Introduction to Credit Derivatives20.2 - Credit Risk20.3 - What are Credit Derivatives?20.4 - Basic Credit Derivatives Structures20.5 - Credit Default Swaps20.5.1 - Credit Events20.5.2 - Contingent Payments20.5.3 - Notional Value20.5.4 - Protection Buyers20.5.5 - Protection Sellers20.5.6 - Premium20.5.7 - The Tenure20.5.8 - The Threshold Risk20.5.9 - The Settlement20.6 - An Example of a CDS20.7 - Counterparty Risk and Synthetic Lending20.8 - Contingent Credit Swaps20.9 - Dynamic Credit Swaps20.10 - Total Return Swaps20.11 - Credit Options20.12 - Credit-linked Notes20.13 - Credit Derivatives Versus Financial Guarantee Products
Notes
Chapter 2
Chapter 4
Chapter 5
Chapter 9
Chapter 20
Bibliography
Glossary
Acknowledgements
Copyright

Content preview from Derivatives and Risk Management

Glossary

Accrued interest: The prorated portion of a bond's coupon since the previous coupon payment.

American options: Options that can be exercised anytime during the life of the option.

Arbitrage: Making profits with zero net investment and taking no risk when there is a mispricing of related securities in the market.

Arbitrager: A trader who enters into arbitrage trades.

Asian options: Options in which pay-off is based on the average price of the underlying asset over an agreed period of time and the exercise price.

At-the-money option: An option where the underlying asset price is close to its strike price.

Backwardation: Occurs when the futures prices are falling with time to expiration.

Badla: A system of forward trading in Indian ...

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