Market Risk: Tools and Uses 4

There are three basic tools for adjusting market risks: (1) forward purchases/sales, (2) swaps, and (3) options. This tool set is fundamental and applicable in all the markets, but there are many variations in how the tools are applied in each market. They can be combined (for example, an option to enter into a swap), and they can have structural variations, such as exotic options, with different payout structures. The three tools themselves are quite straightforward; the many ways they are applied or combined yield the complexity.

These tools are used to hedge, to arbitrage, or to speculate. Hedgers use them to offset existing position(s). Arbitrage traders try to remain risk-neutral while extracting a profit from ...

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