Pricing and Hedging Financial Derivatives: A Guide for Practitioners

1

An Introduction to the Major Asset Classes

This introductory, and slightly eclectic, chapter focuses on the liquid investment asset classes in which derivatives and structured products are normally developed, priced and traded, namely equities, fixed income, commodities and foreign exchange. The aim is not to describe in detail the everyday products traded in these markets but more to give a sense of the general price characteristics of these markets, e.g., how they move through time. There are many excellent product books on the market and we would recommend readers interested in the range of products available to pick up a copy of one of them; we have listed some in the References.

In this chapter, we aim to make some observations on how to model underlying asset price behaviour for each asset class.¹ In order to have a real understanding of the value that can be extracted from financial derivatives, one must understand how prices behave in their composite parts. This is not a quantitative finance textbook, however, and we do not aim to be completely rigorous. Instead, in this chapter as in the others, we try to get across an intuitive (rather than an academic) understanding.²

On the way, we will also highlight some interesting features of the markets under review so that you, the reader, can feel more personal affinity with them; we think that, if your interest is tweaked, you will enjoy the book (and the chapter) much more. Many readers of this book will have experience in ...