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Principles of Financial Engineering, 2nd Edition by Salih N. Neftci

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CHAPTER 1

Introduction

Market professionals and investors take long and short positions on elementary assets such as stocks, default-free bonds and debt instruments that carry a default risk. There is also a great deal of interest in trading currencies, commodities, and, recently, volatility. Looking from the outside, an observer may think that these trades are done overwhelmingly by buying and selling the asset in question outright, for example by paying “cash” and buying a U.S.-Treasury bond. This is wrong. It turns out that most of the financial objectives can be reached in a much more convenient fashion by going through a proper swap. There is an important logic behind this and we choose this as the first principle to illustrate in this introductory ...

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