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

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CHAPTER 10

Options Engineering with Applications

1. Introduction

This chapter discusses traditional option strategies from the financial engineering perspective and provides market-based examples. It then moves on to discuss exotic options. We are concerned with portfolios and positions that are taken with a precise gain-loss profile in mind. The players consciously take risks in the hope of benefiting or protecting themselves from an expected movement in a certain risk factor. Most investor behavior is of this kind. Investors buy a stock with a higher (systematic) risk, in anticipation of higher returns. A high-yield bond carries a higher default probability, which the bond holder is willing to bear. For all the different instruments, there ...

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