book

Derivatives and Risk Management, 2nd Edition by Pearson

Name: Derivatives and Risk Management, 2nd Edition by Pearson
Author: Sundaram Janakiramanan
ISBN: 9789354495748

by Sundaram Janakiramanan

December 2021

Intermediate to advanced

540 pages

19h 22m

English

Pearson India

Read now

Unlock full access

Cover
About Pearson
Title Page
About the Author
Brief Contents
Contents
Preface
1 Introduction
1.1 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 Managing Risks1.10 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 Forward Contracts
2.1 What is a Forward Contract?2.2 The Purpose of Forward Contracts2.3 Advantages of Forward Contracts2.4 Problems with Forward Contracts2.4.1 Parties with Matching Needs2.4.2 Non-performance2.4.3 Non-transferability2.5 The Pricing of Commodity Forward Contracts2.6 Currency Forward Contracts2.6.1 The Operation of the Currency Forward Market2.6.2 Characteristics of Currency Forward Contracts2.6.3 The Pricing of Currency Forward Contracts2.6.4 Covered Interest Arbitrage2.6.5 Rolling Over Currency Forward Contracts2.7 Interest Rate Forwards2.7.1 Mechanics of FRAs2.7.2 The FRA Payment Amount2.7.3 An Alternative View of an FRA and the Settlement Amount2.7.4 Uses of FRAs2.8 Non-deliverable ForwardsCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
3 Futures Contracts
3.1 What is a Futures Contract?3.2 Futures Contracts Versus Forward Contracts3.2.1 Negotiability3.2.2 Standardization3.2.3 Liquidity3.2.4 Performance3.2.5 Cash Needs3.2.6 Ability to Reduce Losses3.3 Participants in Futures Markets3.3.1 Hedgers3.3.2 Speculators3.3.3 Arbitragers3.4 Specifications of Futures Contracts3.4.1 The Underlying Asset3.4.2 The Contract Size3.4.3 Delivery Arrangements: Location3.4.4 Delivery Arrangements: Alternative Grade3.4.5 Delivery Month3.4.6 Delivery Notification3.4.7 Daily Price Movement Limits3.4.8 Position Limits3.5 Closing out the Positions3.6 Arbitrage Between the Futures Market and the Spot Market3.7 Performance of Contracts3.8 The Clearinghouse3.9 Margins and Marking-to-Market3.10 Price Quotes3.11 Settlement Price3.12 Open Interest3.13 The Pattern of Prices3.14 The Relation Between Futures Price and Spot Price3.15 Delivery3.16 Cash Settlement3.17 Types of Orders3.17.1 Market Orders3.17.2 Limit Orders3.17.3 Stop Orders3.17.4 Stop–Limit Orders3.17.5 Other Orders3.18 How to Trade in Futures?3.19 Pricing of Futures ContractsCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY

4 Hedging Strategies Using Futures
4.1 The Principles of Hedging4.2 Long Hedges4.3 Short Hedges4.4 Should Hedging be Undertaken?4.5 Risks in Hedging4.6 Basis Risk4.7 Factors Affecting Basis Risk4.8 The Hedge Ratio4.9 Static and Dynamic Hedging4.10 Strip Hedges and Stack Rolling Hedges4.11 Losses from Hedging Using FuturesCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
5 Single Stock Futures and Stock Index Futures
5.1 Single Stock Futures5.2 What is a Stock Futures Contract?5.3 Hedging Using Single Stock Futures5.3.1 What Type of Hedging is Appropriate?5.3.2 Which Instrument to Use?5.3.3 How Many Contracts to Use?5.3.4 When to Take an Open Position?5.3.5 When to Close the Position?5.3.6 Risks in Hedging Using Single Stock Futures5.4 Speculation Using Stock Futures5.5 Pricing of Single Stock Futures Contracts5.6 Single Stock Futures and Arbitrage5.7 Using Stock Futures for Insurance Purposes5.8 Using Stock Futures for Investment Purposes5.9 Stock Indexes5.10 Stock Index Futures5.11 Stock Index Futures Contracts Traded on the BSE and the NSE5.12 How do Index Futures Work?5.13 Pricing of Index Futures Contracts5.14 Speculation Using Index Futures5.15 Portfolio Insurance Using Index Futures5.16 Index Arbitrage5.17 Program Trading5.18 Hedging the Value of a Portfolio of Shares Using Index Futures5.19 Adjusting Equity Portfolio Beta Using Index Futures5.20 Issues in Using Index FuturesCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
6 Interest Rate Futures
6.1 The Impact of Interest Rate Risk and the Need for Hedging6.2 Interest Rate Futures in India6.3 Bond Futures6.3.1 Pricing of Bond Futures 6.4 Uses of Long-term Interest Rate Futures6.4.1 Directional Trading6.4.2 Calendar-spread Trading6.4.3 Hedging6.4.4 Fixed Income Portfolio Management6.4.5 Changing a Fixed Income Loan to a Floating-rate Loan6.5 Short-term Interest Rate Futures6.6 Pricing of T-bill Futures Contracts6.7 Hedging Using Bill Futures Contracts6.8 Uses of Short-term Interest Rate Futures Contracts6.8.1 Hedging Borrowing Costs6.8.2 Hedging an Investment Yield6.8.3 Hedging a Floating-rate Loan or Strip Hedging6.8.4 Directional Trades6.8.5 Spread Trades6.8.6 Arbitrage Transactions6.8.7 Adjusting the Duration of the Portfolio6.8.8 Cross-hedging6.9 Cautions in Using Interest Rate FuturesCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
7 Currency Futures
7.1 What Are Currency Futures?7.2 The Specifications of Exchange-traded Currency Futures Contracts7.3 The Pricing of Currency Futures7.4 Hedging with Currency Futures7.5 Basis Risk While Using Currency Futures7.6 Speculation Using Currency Futures7.7 Arbitraging with Currency Futures ContractsCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
8 Interest Rate and Currency Swaps
8.1 What are Swaps?8.2 Types of Swaps8.3 Terminologies in Swaps8.4 Interest Rate Swaps8.5 Swap Rates8.6 Rationale for Swap Arrangements8.7 Swap with Intermediaries8.8 Forward Swaps8.9 Swaptions8.10 Uses of Interest Rate Swaps8.11 Valuation of Interest Rate Swaps8.12 Currency Swaps8.12.1 Differences Between an Interest Rate Swap and a Currency Swap8.12.2 Basic Structure of Currency Swaps8.13 Currency Risk in Currency Swaps8.14 Comparative Advantages of Currency Swaps8.15 Uses of Currency Swaps8.16 The Valuation of a Currency Swap8.17 Equity Swaps8.18 The Valuation of an Equity Swap8.19 Commodity Swaps8.20 Risks While Entering into Interest Rate SwapsCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
9 Fundamentals of Options
9.1 Options Issued by Corporations9.1.1 Warrants9.1.2 Employee Stock Options9.1.3 Convertible Bonds9.1.4 Callable Bonds9.1.5 Put Bonds9.1.6 Rights9.2 Options Contracts Between Private Parties9.3 Exchange-traded Options9.4 Options Contracts: An Example9.5 What is an Options Contract?9.6 Options Terminologies9.6.1 The Underlying Asset9.6.2 Call and Put Options9.6.3 The Option Premium9.6.4 Exercising Options9.6.5 The Exercise Price or the Strike Price9.6.6 The Exercise Date or the Strike Date9.6.7 American and European Options9.6.8 Buyers and Writers of Options9.6.9 The Contract Size9.6.10 In-the-money, At-the-money and Out-of-money Options9.7 Exchange-traded and OTC Options: A Comparison9.7.1 Guarantee of Performance in Exchange-traded Options9.7.2 Margin Requirements9.7.3 Margin Calculation9.7.4 Standardization of Contracts9.7.5 Exercise Dates9.7.6 Exercise Prices9.7.7 Options Classes and Options Series9.8 Trading of Options9.8.1 Types of Orders9.8.2 Offsetting Orders9.9 Price Quotes9.10 Protection Against Corporate ActionsCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
10 Call and Put Options
10.1 What Are Call Options?10.2 The Terminal Value of a Call Option10.3 Gains and Losses from Purchasing Call Options10.4 Value of a Call Option Before Maturity10.5 Minimum and Maximum Values of a Call10.6 When to Exercise an American Call Option10.7 From a Call Option Writer’s Point of View10.7.1 The Terminal Value of a Written Call10.7.2 Gains and Losses for a Call Writer10.8 Comparison Between the Gains Made by a Call Buyer and a Call Writer10.9 When to Buy and When to Write a Call Option?10.10 Put Options10.10.1 What Are Put Options?10.10.2 Rationale for Put Options10.11 The Terminal Value of a Put Option10.12 Gains and Losses from Purchasing Put Options10.13 Value of a Put Option Before Maturity10.14 Minimum and Maximum Values of Put10.15 When to Exercise a Put Option10.16 From a Put Option Writer’s Point of View10.16.1 The Terminal Value of a Written Put10.16.2 Gains and Losses for a Put Writer10.17 Comparison Between the Gains Made by a Put Buyer and a Put Writer10.18 When to Buy and When to Write a Put Option10.19 Comparison Between Calls and PutsCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
11 Combinations of Options: Trading Strategies
11.1 Naked or Uncovered Positions11.1.1 Naked Long Stock Positions11.1.2 Naked Short Stock Positions11.1.3 Naked Bought Calls11.1.4 Naked Written Calls11.1.5 Naked Bought Puts11.1.6 Naked Written Puts11.2 Hedge or Covered Positions11.2.1 Covered Call Writing11.2.2 Reverse Hedges11.2.3 Protective Puts11.2.4 Short Stocks and Short Puts11.2.5 Partial Hedges11.2.6 Summary of Hedged Positions11.3 Spread Positions11.3.1 Money Spread Using Calls11.3.2 Money Spreads Using Puts11.3.3 Box Spreads11.3.4 Butterfly Spreads11.3.5 Calendar Spreads11.3.6 Iron Condor Spreads11.4 Combinations of Puts and Calls11.4.1 Straddles11.4.2 Strips11.4.3 Straps11.4.4 Strangles11.4.5 Other Pay-offs11.5 Losses from Options TradingCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
12 Put–Call Parity
12.1 Risk-free Security12.2 Strategies Using Options, a Risk-free Security and Underlying Assets12.2.1 Combination of Call Options and Risk-free Securities12.2.2 Combination of Long Stocks and Long Puts12.3 The Put–Call Relationship12.4 Put–Call Arbitrage12.5 Creation of Synthetic Securities12.5.1 Creation of Synthetic Puts12.5.2 The Written Put Strategy12.5.3 The Bought Call Strategy12.5.4 The Written Call Strategy12.5.5 The Strategy of Investing at a Risk-free Rate12.5.6 The Strategy for Borrowing at a Risk-free Rate12.5.7 Cautions in Creating Synthetic Positions12.6 Put–Call Parity for Dividend-paying Stocks: European Options12.7 Put–Call Parity for American Options12.7.1 Early Exercise of American Call Options: Non-dividend-paying Stock12.7.2 Early Exercise of Call Options: Dividend-paying Stock12.7.3 Early Exercise of Put Options: Non-dividend-paying Stock12.7.4 Put–Call Parity for American Options When Dividends Are Not Paid12.7.5 Put–Call Parity for American Options When Dividends Are Paid12.8 Implications of Put–Call Parity12.9 Put–Call Parity and Regulatory ArbitrageCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
13 The Binomial Options Pricing Model
13.1 The Binomial Options Pricing Model for Call Options13.2 The Binomial Options Pricing Model for Put Options13.3 The Relation Between the Hedge Ratios for Call and Put Options13.4 The No-arbitrage Pricing Argument13.5 The Derivation of the Binomial Options Pricing Model13.6 The Single-period Binomial Options Pricing Model13.7 The Two-period Binomial Options Pricing Model13.8 The Multi-period Binomial Options Pricing Model13.9 The Determination of u and d13.10 The Valuation of a European Call Paying a Given Dividend Amount13.11 The Valuation of an American Call Paying a Given Dividend Amount13.12 The Binomial Put Options Pricing ModelCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
14 The Black–Scholes Options Pricing Model
14.1 The History of Options Pricing Research14.2 Stock Price Behaviour14.2.1 Lognormal Distribution14.2.2 The Valuation of Options14.3 The Assumptions in the Black–Scholes Options Pricing Model14.4 The Black–Scholes Model for Pricing Call Options14.5 The Black–Scholes Model for Pricing Put Options14.6 Determinants of Options Prices14.6.1 The Current Price of the Underlying Asset14.6.2 The Exercise Price14.6.3 The Time to Expiration14.6.4 Volatility of the Underlying Asset14.6.5 The Risk-free Rate14.7 The Options Pricing Model for Securities that Pay Known Dividends14.8 Volatility14.9 Implied Volatility14.10 Volatility SmileCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
15 Currency Options, Interest Rate Options and Options on Futures
15.1 Currency Options15.2 Interest Rate Options15.2.1 Bond Options15.2.2 Embedded Bond Options15.2.3 Interest Rate Options15.3 Interest Rate Caps, Floors and Collars15.3.1 Interest Rate Caps15.3.2 Interest Rate Floors15.3.3 Interest Rate Collars15.4 Pricing Interest Rate Options15.5 Valuing an Interest Rate Cap or Floor15.6 Options on Futures or Futures Options15.6.1 Model for Valuing Options on Futures ContractsCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
16 Value-at-risk
16.1 Consider the following situations 16.2 What is Value-at-Risk? 16.2.1. Characteristics of Risk16.2.2. A Brief History of Value-at-risk16.3 Calculation of Value-at-risk16.4 Linear Transformation16.4.1 Issues with Linear Transformation16.5 Quadratic Transformation16.6 Historic Simulation16.6.1 Problems with Historical Simulation16.7 Monte Carlo Simulation16.8 Comparison of the Methods16.9 Use of Value-at-risk16.10 Limitations of Value-at-riskCHAPTER SUMMARYREVIEW QUESTIONSPROBLEMSCASE STUDY
Further Readings
Index
Copyright

Content preview from Derivatives and Risk Management, 2nd Edition by Pearson

14 The Black–Scholes Options Pricing Model

Learning Objectives

After completing this chapter, you will be able to answer the following questions:

What are the assumptions made in the Black–Scholes options pricing model?
What is meant by no-arbitrage options pricing?
How to calculate the price of a call option using the Black–Scholes model?
How to calculate the price of a put option using the Black–Scholes model?
What factors affect the price of call and put options?
What is implied volatility and how can it be used?
What is meant by the volatility smile and how can it be used?

BOX 14.1 Nobel Prize in Economics for Scholes and Merton

The Royal Swedish Academy of Sciences has decided to award the Bank of Sweden Prize in Economic Sciences ...

Become an O’Reilly member and get unlimited access to this title plus top books and audiobooks from O’Reilly and nearly 200 top publishers, thousands of courses curated by job role, 150+ live events each month,
and much more.

Read now

Unlock full access

More than 5,000 organizations count on O’Reilly

O’Reilly covers everything we've got, with content to help us build a world-class technology community, upgrade the capabilities and competencies of our teams, and improve overall team performance as well as their engagement.

Julian F.

Head of Cybersecurity

I wanted to learn C and C++, but it didn't click for me until I picked up an O'Reilly book. When I went on the O’Reilly platform, I was astonished to find all the books there, plus live events and sandboxes so you could play around with the technology.

Addison B.

Field Engineer

I’ve been on the O’Reilly platform for more than eight years. I use a couple of learning platforms, but I'm on O'Reilly more than anybody else. When you're there, you start learning. I'm never disappointed.

Amir M.

Data Platform Tech Lead

I'm always learning. So when I got on to O'Reilly, I was like a kid in a candy store. There are playlists. There are answers. There's on-demand training. It's worth its weight in gold, in terms of what it allows me to do.

Mark W.

Embedded Software Engineer

Publisher Resources

ISBN: 9789354495748

Cloud Computing

Data Engineering

Data Science

AI & ML

Programming Languages

Software Architecture

IT/Ops

Security

Design

Business

Soft Skills

Derivatives and Risk Management, 2nd Edition by Pearson

by Sundaram Janakiramanan

14