Principles of Financial Engineering, 3rd Edition

Chapter 1

Introduction

This chapter provides an overview of some of the concepts and applications discussed in the book. We introduce the concept of replication and apply it to forwards, interest rate swaps, credit default swaps, and total returns swaps. We highlight the importance of funding, regulatory, balance sheet, and tax considerations in financial engineering.

Keywords

Forwards; money market; swaps; trading volatility

Chapter Outline

1.1 A Unique Instrument 2

1.1.1 Buying a Default-Free Bond 3

1.1.2 Buying Stocks 5

1.1.3 Buying a Defaultable Bond 7

1.1.4 First Conclusions 10

1.2 A Money Market Problem 10

1.2.1 The Problem 11

1.2.2 Solution 11

1.2.3 Some Implications 13

1.3 A Taxation Example 13

1.3.1 The Problem 14

1.3.1.1 Another strategy  ...