Derivatives: Markets, Valuation, and Risk Management

Preface

The book's title is Derivatives: Markets, Valuation, and Risk Management. In a nutshell, that is what it intends to provide—an understanding of derivatives markets, derivatives valuation, and risk management using derivative contracts. The first part of the book—Markets—sketches the landscape. What are derivative contracts? Where do they trade? Why do they exist? While a seemingly endless number of derivative contract structures will appear as we proceed through the chapters of the book, do not be misled. Only two basic contract structures exist—a forward and an option. All other product structures are nothing more than portfolios of forwards and options. Similarly, derivative products are offered by an almost endless number of firms and institutions in the market-place—brokerages houses, banks, investment houses, commodity producers, importers, exporters, and so on. Again, do not be misled. Fundamentally there are only two types of derivatives markets—exchange-traded markets and over-the-counter (OTC) markets. Exchanges facilitate trading in standardized contracts. They offer deep and liquid markets, and the financial integrity of trades is guaranteed by the exchange's clearinghouse. OTC markets, on the other hand, can tailor contracts to meet customer needs, however, counterparties are left to their own devices to arrange protection from counterparty default. Finally, why do derivatives markets flourish, considering that they are redundant securities, that is, they derive ...