Equity, Currency, and Commodity Markets*
Having covered fixed-income instruments, we now turn to equity, currency, and commodity markets. Equities, or common stocks, represent ownership shares in a corporation. Due to the uncertainty in their cash flows, as well as in the appropriate discount rate, equities are much more difficult to value than fixed-income securities. They are also less amenable to the quantitative analysis that is used in fixed-income markets. Equity derivatives, however, can be priced reasonably precisely in relation to underlying stock prices.
Next, the foreign currency markets include spot, forward, options, futures, and swaps markets. The foreign exchange markets are by far the largest financial markets in the world, with daily turnover above $3 trillion.
Commodity markets consist of agricultural products, metals, energy, and other products. Commodities differ from financial assets, as their holding provides an implied benefit known as convenience yield but also incurs storage costs.
Section 11.1 introduces equity markets and presents valuation methods as well as some evidence on equity risk. Section 11.2 then provides an overview of important equity derivatives, including stock index contracts such as futures, options, and swaps as well as derivatives on single stocks. For most of these contracts, pricing methods have been developed in the previous chapters and do not require special treatment. Convertible bonds and warrants will be covered in ...