Determination of Forward and Futures Prices


 Jonathan Blankenship
 4 years ago
 Views:
Transcription
1 Determination of Forward and Futures Prices Options, Futures, and Other Derivatives, 8th Edition, Copyright John C. Hull 2012
2 Short selling A popular trading (arbitrage) strategy is the shortselling or shorting. This trade involves selling an asset that is not owned by the seller, and that the seller has borrowed. Short selling is motivated by the belief that an asset s price will decline, enabling it to be bought back at a lower price to make a profit. Short selling is largely prompted by speculation. Short sellers take advantage of any likely arbitrage opportunities. 2
3 Short selling Investor A instructs a broker to short 500 shares who does not own. The broker will borrow the shares from another client, say Investor B, and sell them in the market. Investor A can maintain the short position for as long as desired, provided there are always shares to borrow. At some stage, Investor A will close out the position by purchasing the 500 shares. The 500 shares are replaced in the account of Investor B. 3
4 Short selling Investor A takes a profit if the stock price has declined and a loss if it has risen. If at any time while the contract is open the broker is not able to borrow shares, investor A is forced to close out the position, even if not ready to do so. Investor A must pay dividends and other benefits to the owner of the shares, i.e. to Investor B via the broker. A broker fee is also charged to Investor A for borrowing the shares. 4
5 Short selling Investor A is required to maintain a margin account with the broker. The margin account consists of cash or marketable securities deposited by the Investor with the broker to guarantee that the investor will not walk away from the short position if the share price increases. An initial margin is required and if there are adverse movements (i.e., increases) in the price of the asset that is being shorted, additional margin may be required. If the additional margin is not provided, the short position is closed out. 5
6 Short selling: Example Consider the position of Investor A who shorts 500 shares in April when the price per share is $120. Investor A closes out the position by buying them back in July when the price per share is $100. Suppose that a dividend of $1 per share is paid in May. Investor A receives 500 x $120 = $60,000 in April when the short position is initiated. The dividend leads to a payment by Investor A of 500 x $1 = $500 in May. Investor A also pays 500 x $100 = $50,000 for shares when the position is closed out in July. The net gain is: $60,000  $500  $50,000 = $9,500 assuming there is no fee for borrowing the shares. 6
7 Short selling Massive short selling is a practice that is often observed after the burst of a price bubble. Examples are the Dutch Tulipmania in the seventeenth century, the U.S. stock price crash in 1929, the NASDAQ price bubble of , etc. Since the practice of short selling is alleged to magnify the decline of asset prices, it has been banned and restricted many times during history. As such, short selling bans have been commonly used as a regulatory measure to stabilise prices during downturns in the economy. 7
8 Short selling The most recent example was in September of 2008 with the prohibition of short selling by the U.S. Securities and Exchange Commission (SEC) for 799 financial companies in an effort to stabilise those companies. At the same time the U.K. Financial Services Authority (FSA) prohibited short selling for 32 financial companies. On September 22, Australia enacted even more extensive measures with a total ban of short selling. 8
9 Pricing Futures and Forward Contracts S 0 : Spot price today F 0 : Futures or forward price today T: Time until delivery date r: Riskfree interest rate for maturity T r is the rate at which money is borrowed or lent when there is no credit risk, so that the money is certain to be repaid. Participants in derivatives markets have traditionally assumed that LIBOR rates are the relevant riskfree rates. 9
10 Pricing Futures and Forward Contracts LIBOR is a reference interest rate; it is designed to reflect the rate of interest at which banks are prepared to make large wholesale deposits with other banks. LIBOR is quoted in all major currencies for maturities up to 12 months: E.g., 1month LIBOR is the rate at which 1month deposits are offered. A deposit with a bank can be regarded as a loan to that bank. A bank must satisfy certain creditworthiness criteria in order to be able to receive deposits from another bank at LIBOR. Typically, it must have a AA credit rating. LIBID is the rate which a AA bank is prepared to pay on deposits from another bank 10
11 Pricing Futures and Forward Contracts Arbitrage arguments are used to determine the forward and futures prices of an asset from its spot price and other observable market variables. In other words, it is the trading activities of market participants to take advantage of arbitrage opportunities as they occur that determine the relationship between forward and spot prices. 11
12 Forward price of an asset Suppose an asset that provides the holder with no income: nondividendpaying stocks, or zerocoupon bonds. Consider a long forward contract to purchase a nondividendpaying stock in 3 months. Assume the current stock price is $40 and the 3month riskfree interest rate is 5% per annum. Suppose that the forward price is relatively high at $43. An arbitrageur can borrow $40 at the riskfree interest rate of 5% per annum, buy one share, and short a forward contract to sell one share in 3 months. 12
13 Forward price of an asset If the spot price of an investment asset is S 0 and the futures price for a contract deliverable in T years is F 0, then: F 0 = S 0 e rt where r is the Tyear riskfree rate of interest. 13
14 Interest Rates Compounding When we compound m times per year at rate R an amount A grows to A(1+R/m) m in one year Compounding frequency Value of $100 in one year at 10% Annual (m=1) Semiannual (m=2) Quarterly (m=4) Monthly (m=12) Weekly (m=52) Daily (m=365)
15 Interest Rates Continuous Compounding In the limit as we compound more and more frequently we obtain continuously compounded interest rates. $100 grows to $100e RT when invested at a continuously compounded rate R for time T. $100 received at time T discounts to $100e RT at time zero when the continuously compounded discount rate is R. 15
16 Forward price of an asset At the end of the 3 months, the arbitrageur delivers the share and receives $43.00 The sum of money required to pay off the loan is: Hence, the arbitrageur locks in a profit of $ $40.50 = $2.50 at the end of the 3month period. 16
17 Forward price of an asset Suppose that the forward price is at $39.00 An arbitrageur can short one share, invest the money brought in from a transaction of the short sale at 5% per annum for 3 months, and take a long position in a 3month forward contract. The proceeds of the short sale in 3 months grow to: At the end of the 3 months, the arbitrageur pays $39, takes delivery of the share under the terms of the forward contract, and uses it to close out the short position. A net gain of $ $39.00 = $1.50 is made at the end of the 3 months. 17
18 Forward price of an asset A net gain of $ $39.00 = $1.50 is made at the end of the 3 months. Overall: a) The first arbitrage works when the forward price is greater than $ b) The second arbitrage works when the forward price is less than $ We deduce that for there to be no arbitrage the forward price must be exactly $
19 Forward price of an asset Short sales are not possible for all assets and sometimes is banned from authorities. This does not matter: we can still derive and use the same formula (F 0 = S 0 e rt ). All that we require is that there be a significant number of people who hold the asset purely for investment (and by definition this is always true of an investment asset). If the forward price is too low, they will find it attractive to sell the asset and take a long position in a forward contract. 19
20 A Known Income Consider a forward contract on an asset that will provide a perfectly predictable cash income to the holder. Examples are stocks paying known dividends and couponbearing bonds. We adopt the same approach as before and obtain: F 0 = (S 0 I )e rt where I is the present value of the income during life of forward contract. 20
21 A Known Yield Consider the situation where the asset underlying a forward contract provides a known yield. This means that the income is known when expressed as a percentage of the asset s price at the time the income is paid. Suppose that an asset is expected to provide a yield of 5% per annum. This could mean that income is paid once a year and is equal to 5% of the asset price at the time it is paid. The formula is: F 0 = S 0 e (r q )T where q is the average yield during the life of the contract (expressed with continuous compounding). 21
22 Forward Prices and Futures Prices When the shortterm riskfree interest rate is constant, the forward price for a contract with a certain delivery date is in theory the same as the futures price for a contract with that delivery date. When interest rates vary, forward and futures prices are in theory no longer the same. We can get a sense of the nature of the relationship by considering the situation where the price of the underlying asset, S, is strongly positively correlated with interest rates. 22
23 Forward Prices and Futures Prices When S increases, an investor who holds a long futures position makes an immediate gain because of the daily settlement procedure. The positive correlation indicates that it is likely that interest rates have also increased. Similarly, when S decreases, the investor will incur an immediate loss. 23
24 Forward Prices and Futures Prices An investor holding a forward contract rather than a futures contract is not affected in this way by interest rate movements. A long futures contract will be slightly more attractive than a similar long forward contract. Hence, when S is strongly positively correlated with interest rates, futures prices will tend to be slightly higher than forward prices. When S is strongly negatively correlated with interest rates, a similar argument shows that forward prices will tend to be slightly higher than futures prices. 24
25 Futures Prices of Stock Indices We have introduced futures on stock indices and showed how a stock index futures contract is a useful tool in managing equity portfolios. We now consider how index futures prices are determined. A stock index can usually be regarded as the price of an investment asset that pays dividends. The investment asset is the portfolio of stocks underlying the index, and the dividends paid by the investment asset are the dividends that would be received by the holder of this portfolio. 25
26 Futures Prices of Stock Indices It is usually assumed that the dividends provide a known yield rather than a known cash income. The following formula gives the futures price of stock indices: F 0 = S 0 e (r q )T where q is the average dividend yield on the portfolio represented by the index during life of contract. 26
27 Index Arbitrage When F 0 > S 0 e (rq)t an arbitrageur buys the stocks underlying the index and sells futures. When F 0 < S 0 e (rq)t an arbitrageur buys futures and shorts or sells the stocks underlying the index. To do index arbitrage, a trader must be able to trade both the index futures contract and the portfolio of stocks underlying the index very quickly at the prices quoted in the market. 27
28 Forward and Futures Prices: Summary 28
Determination of Forward and Futures Prices. Chapter 5
Determination of Forward and Futures Prices Chapter 5 Fundamentals of Futures and Options Markets, 8th Ed, Ch 5, Copyright John C. Hull 2013 1 Consumption vs Investment Assets Investment assets are assets
More information2 Stock Price. Figure S1.1 Profit from long position in Problem 1.13
Problem 1.11. A cattle farmer expects to have 12, pounds of live cattle to sell in three months. The livecattle futures contract on the Chicago Mercantile Exchange is for the delivery of 4, pounds of cattle.
More informationFigure S9.1 Profit from long position in Problem 9.9
Problem 9.9 Suppose that a European call option to buy a share for $100.00 costs $5.00 and is held until maturity. Under what circumstances will the holder of the option make a profit? Under what circumstances
More informationNotes for Lecture 2 (February 7)
CONTINUOUS COMPOUNDING Invest $1 for one year at interest rate r. Annual compounding: you get $(1+r). Semiannual compounding: you get $(1 + (r/2)) 2. Continuous compounding: you get $e r. Invest $1 for
More informationAssumptions: No transaction cost, same rate for borrowing/lending, no default/counterparty risk
Derivatives Why? Allow easier methods to short sell a stock without a broker lending it. Facilitates hedging easily Allows the ability to take long/short position on less available commodities (Rice, Cotton,
More informationLecture 4: Properties of stock options
Lecture 4: Properties of stock options Reading: J.C.Hull, Chapter 9 An European call option is an agreement between two parties giving the holder the right to buy a certain asset (e.g. one stock unit)
More informationDerivative: a financial instrument whose value depends (or derives from) the values of other, more basic, underlying values (Hull, p. 1).
Introduction Options, Futures, and Other Derivatives, 7th Edition, Copyright John C. Hull 2008 1 Derivative: a financial instrument whose value depends (or derives from) the values of other, more basic,
More informationSession IX: Lecturer: Dr. Jose Olmo. Module: Economics of Financial Markets. MSc. Financial Economics
Session IX: Stock Options: Properties, Mechanics and Valuation Lecturer: Dr. Jose Olmo Module: Economics of Financial Markets MSc. Financial Economics Department of Economics, City University, London Stock
More informationChapter 3: Commodity Forwards and Futures
Chapter 3: Commodity Forwards and Futures In the previous chapter we study financial forward and futures contracts and we concluded that are all alike. Each commodity forward, however, has some unique
More informationChapter 1  Introduction
Chapter 1  Introduction Derivative securities Futures contracts Forward contracts Futures and forward markets Comparison of futures and forward contracts Options contracts Options markets Comparison of
More informationIntroduction to Futures Contracts
Introduction to Futures Contracts September 2010 PREPARED BY Eric Przybylinski Research Analyst Gregory J. Leonberger, FSA Director of Research Abstract Futures contracts are widely utilized throughout
More informationSOLUTION1. exercise 1
exercise 1 Stock BBB has a spot price equal to 80$ and a dividend equal to 10$ will be paid in 5 months. The on year interest rate is equal to 8% (c.c). 1. Calculate the 6 month forward price? 2. Calculate
More informationSOCIETY OF ACTUARIES FINANCIAL MATHEMATICS. EXAM FM SAMPLE QUESTIONS Financial Economics
SOCIETY OF ACTUARIES EXAM FM FINANCIAL MATHEMATICS EXAM FM SAMPLE QUESTIONS Financial Economics June 2014 changes Questions 130 are from the prior version of this document. They have been edited to conform
More informationLearning Curve Forward Rate Agreements Anuk Teasdale
Learning Curve Forward Rate Agreements Anuk Teasdale YieldCurve.com 2004 Page 1 In this article we review the forward rate agreement. Money market derivatives are priced on the basis of the forward rate,
More informationLecture 12. Options Strategies
Lecture 12. Options Strategies Introduction to Options Strategies Options, Futures, Derivatives 10/15/07 back to start 1 Solutions Problem 6:23: Assume that a bank can borrow or lend money at the same
More informationHow CFD Trading Works?
What are CFD s In finance, a contract for difference (CFD) is a contract between two parties, typically described as "buyer" and "seller", stipulating that the seller will pay to the buyer the difference
More informationHedging Strategies Using Futures. Chapter 3
Hedging Strategies Using Futures Chapter 3 Fundamentals of Futures and Options Markets, 8th Ed, Ch3, Copyright John C. Hull 2013 1 The Nature of Derivatives A derivative is an instrument whose value depends
More informationLoan Disclosure Statement
ab Loan Disclosure Statement Risk Factors You Should Consider Before Using Margin or Other Loans Secured by Your Securities Accounts This brochure is only a summary of certain risk factors you should consider
More informationCFA Level 2 Derivatives  I
CFA Level 2 Derivatives  I EduPristine www.edupristine.com Agenda Forwards Markets and Contracts Future Markets and Contracts Option Markets and Contracts 1 Forwards Markets and Contracts 2 Pricing and
More informationDERIVATIVES Presented by Sade Odunaiya Partner, Risk Management Alliance Consulting DERIVATIVES Introduction Forward Rate Agreements FRA Swaps Futures Options Summary INTRODUCTION Financial Market Participants
More informationIntroduction to Equity Derivatives on Nasdaq Dubai NOT TO BE DISTRIUTED TO THIRD PARTIES WITHOUT NASDAQ DUBAI S WRITTEN CONSENT
Introduction to Equity Derivatives on Nasdaq Dubai NOT TO BE DISTRIUTED TO THIRD PARTIES WITHOUT NASDAQ DUBAI S WRITTEN CONSENT CONTENTS An Exchange with Credentials (Page 3) Introduction to Derivatives»
More informationLecture 4: Derivatives
Lecture 4: Derivatives School of Mathematics Introduction to Financial Mathematics, 2015 Lecture 4 1 Financial Derivatives 2 uropean Call and Put Options 3 Payoff Diagrams, Short Selling and Profit Derivatives
More informationor enters into a Futures contract (either on the IPE or the NYMEX) with delivery date September and pay every day up to maturity the margin
CashFutures arbitrage processes Cash futures arbitrage consisting in taking position between the cash and the futures markets to make an arbitrage. An arbitrage is a trade that gives in the future some
More informationLearning Curve Interest Rate Futures Contracts Moorad Choudhry
Learning Curve Interest Rate Futures Contracts Moorad Choudhry YieldCurve.com 2004 Page 1 The market in shortterm interest rate derivatives is a large and liquid one, and the instruments involved are
More information11 Option. Payoffs and Option Strategies. Answers to Questions and Problems
11 Option Payoffs and Option Strategies Answers to Questions and Problems 1. Consider a call option with an exercise price of $80 and a cost of $5. Graph the profits and losses at expiration for various
More informationINVESTMENT DICTIONARY
INVESTMENT DICTIONARY Annual Report An annual report is a document that offers information about the company s activities and operations and contains financial details, cash flow statement, profit and
More informationIntroduction, Forwards and Futures
Introduction, Forwards and Futures Liuren Wu Zicklin School of Business, Baruch College Fall, 2007 (Hull chapters: 1,2,3,5) Liuren Wu Introduction, Forwards & Futures Option Pricing, Fall, 2007 1 / 35
More informationFinance 350: Problem Set 6 Alternative Solutions
Finance 350: Problem Set 6 Alternative Solutions Note: Where appropriate, the final answer for each problem is given in bold italics for those not interested in the discussion of the solution. I. Formulas
More informationPowerful tools for investing, speculating or hedging
Powerful tools for investing, speculating or hedging DERIVATIVE MARKET Equity Derivatives Single Stock Futures www.jse.co.za Johannesburg Stock Exchange Single Stock Futures are powerful tools for investing,
More informationChapter 15 OPTIONS ON MONEY MARKET FUTURES
Page 218 The information in this chapter was last updated in 1993. Since the money market evolves very rapidly, recent developments may have superseded some of the content of this chapter. Chapter 15 OPTIONS
More informationObligatory transactions on a specified date at a predetermined price
Obligatory transactions on a specified date at a predetermined price DERIVATIVE MARKET Bond Derivatives Bond Futures www.jse.co.za Johannesburg Stock Exchange A bond future is a contractual obligation
More informationIn effect CFD s are financial derivatives, originally known as Traded Options, that allow traders to take advantage of prices moving up (long
What are CFD s In finance, a contract for difference (CFD) is a contract between two parties, typically described as "buyer" and "seller", stipulating that the seller will pay to the buyer the difference
More informationHomework Margin Purchases. Dr. Patrick Toche
Homework Margin Purchases Dr. Patrick Toche A dagger indicates a possibly more challenging question. Maintenance Margin 1. You are bullish on Telecom stock. The current market price is $50 per share, and
More informationShort Sale. Dr. Patrick Toche
Short Sale Dr. Patrick Toche References : Zvi Bodie, Alex Kane, Alan J. Marcus. Essentials of Investment. McGraw Hill Irwin. Chapter 3 of the BodieKaneMarcus textbook will be followed closely. Other
More informationFinding the Payment $20,000 = C[1 1 / 1.0066667 48 ] /.0066667 C = $488.26
Quick Quiz: Part 2 You know the payment amount for a loan and you want to know how much was borrowed. Do you compute a present value or a future value? You want to receive $5,000 per month in retirement.
More informationCHAPTER 22: FUTURES MARKETS
CHAPTER 22: FUTURES MARKETS PROBLEM SETS 1. There is little hedging or speculative demand for cement futures, since cement prices are fairly stable and predictable. The trading activity necessary to support
More informationANALYSIS OF FIXED INCOME SECURITIES
ANALYSIS OF FIXED INCOME SECURITIES Valuation of Fixed Income Securities Page 1 VALUATION Valuation is the process of determining the fair value of a financial asset. The fair value of an asset is its
More informationChapter 5  Determination of Forward and Futures Prices
Chapter 5  Determination of Forward and Futures Prices Investment assets vs. consumption assets Short selling Assumptions and notations Forward price for an investment asset that provides no income Forward
More informationChapter 5 Financial Forwards and Futures
Chapter 5 Financial Forwards and Futures Question 5.1. Four different ways to sell a share of stock that has a price S(0) at time 0. Question 5.2. Description Get Paid at Lose Ownership of Receive Payment
More informationManual for SOA Exam FM/CAS Exam 2.
Manual for SOA Exam FM/CAS Exam 2. Chapter 7. Derivatives markets. c 2009. Miguel A. Arcones. All rights reserved. Extract from: Arcones Manual for the SOA Exam FM/CAS Exam 2, Financial Mathematics. Fall
More informationForwards and Futures
Prof. Alex Shapiro Lecture Notes 16 Forwards and Futures I. Readings and Suggested Practice Problems II. Forward Contracts III. Futures Contracts IV. ForwardSpot Parity V. Stock Index ForwardSpot Parity
More informationSOCIETY OF ACTUARIES FINANCIAL MATHEMATICS EXAM FM SAMPLE QUESTIONS
SOCIETY OF ACTUARIES EXAM FM FINANCIAL MATHEMATICS EXAM FM SAMPLE QUESTIONS This page indicates changes made to Study Note FM0905. April 28, 2014: Question and solutions 61 were added. January 14, 2014:
More informationChapter 6. Interest Rates And Bond Valuation. Learning Goals. Learning Goals (cont.)
Chapter 6 Interest Rates And Bond Valuation Learning Goals 1. Describe interest rate fundamentals, the term structure of interest rates, and risk premiums. 2. Review the legal aspects of bond financing
More informationReading: Chapter 19. 7. Swaps
Reading: Chapter 19 Chap. 19. Commodities and Financial Futures 1. The mechanics of investing in futures 2. Leverage 3. Hedging 4. The selection of commodity futures contracts 5. The pricing of futures
More informationHedging with Futures and Options: Supplementary Material. Global Financial Management
Hedging with Futures and Options: Supplementary Material Global Financial Management Fuqua School of Business Duke University 1 Hedging Stock Market Risk: S&P500 Futures Contract A futures contract on
More informationHomework Margin Purchases. Dr. Patrick Toche
Homework Margin Purchases Dr. Patrick Toche A dagger indicates a possibly more challenging question. Maintenance Margin 1. You are bullish on Telecom stock. The current market price is $50 per share, and
More informationReview for Exam 1. Instructions: Please read carefully
Review for Exam 1 Instructions: Please read carefully The exam will have 21 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation
More informationName: 1 (5) a b c d e TRUE/FALSE 1 (2) TRUE FALSE. 2 (5) a b c d e. 3 (5) a b c d e 2 (2) TRUE FALSE. 4 (5) a b c d e.
Name: Thursday, February 28 th M375T=M396C Introduction to Actuarial Financial Mathematics Spring 2013, The University of Texas at Austin InTerm Exam I Instructor: Milica Čudina Notes: This is a closed
More informationForward Contracts and Forward Rates
Forward Contracts and Forward Rates Outline and Readings Outline Forward Contracts Forward Prices Forward Rates Information in Forward Rates Reading Veronesi, Chapters 5 and 7 Tuckman, Chapters 2 and 16
More informationTrading Costs. Characteristics of wellfunctioning markets
Trading Costs Commission: fee paid to broker for making the transaction Spread: cost of trading with dealer Bid: price dealer will buy from you Ask: price dealer will sell to you Spread: ask  bid Combination:
More informationLecture 7: Bounds on Options Prices Steven Skiena. http://www.cs.sunysb.edu/ skiena
Lecture 7: Bounds on Options Prices Steven Skiena Department of Computer Science State University of New York Stony Brook, NY 11794 4400 http://www.cs.sunysb.edu/ skiena Option Price Quotes Reading the
More informationINSTALMENT WARRANT MECHANICS
INSTALMENT WARRANT MECHANICS Antonie A. Kotzé Financial Chaos Theory consultant@quantonline.co.za Abstract Instalment warrants are very popular in Australia and these instruments have been listed by Nedbank
More informationFinancial Instruments. Chapter 2
Financial Instruments Chapter 2 Major Types of Securities debt money market instruments bonds common stock preferred stock derivative securities 12 Markets and Instruments Money Market debt instruments
More informationChapter 2 An Introduction to Forwards and Options
Chapter 2 An Introduction to Forwards and Options Question 2.1. The payoff diagram of the stock is just a graph of the stock price as a function of the stock price: In order to obtain the profit diagram
More informationA) 1.8% B) 1.9% C) 2.0% D) 2.1% E) 2.2%
1 Exam FM Questions Practice Exam 1 1. Consider the following yield curve: Year Spot Rate 1 5.5% 2 5.0% 3 5.0% 4 4.5% 5 4.0% Find the four year forward rate. A) 1.8% B) 1.9% C) 2.0% D) 2.1% E) 2.2% 2.
More informationHow do CFDs work? CFD trading is similar to traditional share dealing, with a few exceptions.
What is a CFD? A CFD is an agreement to exchange the difference between the opening and closing prices of the share, index or commodity between the time at which a contract is opened and the time at which
More informationEC372 Bond and Derivatives Markets Topic #5: Options Markets I: fundamentals
EC372 Bond and Derivatives Markets Topic #5: Options Markets I: fundamentals R. E. Bailey Department of Economics University of Essex Outline Contents 1 Call options and put options 1 2 Payoffs on options
More informationTHE STOCK MARKET GAME GLOSSARY
THE STOCK MARKET GAME GLOSSARY Accounting: A method of recording a company s financial activity and arranging the information in reports that make the information understandable. Accounts payable: The
More informationCall and Put. Options. American and European Options. Option Terminology. Payoffs of European Options. Different Types of Options
Call and Put Options A call option gives its holder the right to purchase an asset for a specified price, called the strike price, on or before some specified expiration date. A put option gives its holder
More informationEquityindexlinked swaps
Equityindexlinked swaps Equivalent to portfolios of forward contracts calling for the exchange of cash flows based on two different investment rates: a variable debt rate (e.g. 3month LIBOR) and the
More informationPricing Forwards and Swaps
Chapter 7 Pricing Forwards and Swaps 7. Forwards Throughout this chapter, we will repeatedly use the following property of noarbitrage: P 0 (αx T +βy T ) = αp 0 (x T )+βp 0 (y T ). Here, P 0 (w T ) is
More informationLecture 5: Put  Call Parity
Lecture 5: Put  Call Parity Reading: J.C.Hull, Chapter 9 Reminder: basic assumptions 1. There are no arbitrage opportunities, i.e. no party can get a riskless profit. 2. Borrowing and lending are possible
More informationChapter 16: Financial Risk Management
Chapter 16: Financial Risk Management Introduction Overview of Financial Risk Management in Treasury Interest Rate Risk Foreign Exchange (FX) Risk Commodity Price Risk Managing Financial Risk The Benefits
More informationRigensis Bank AS Information on the Characteristics of Financial Instruments and the Risks Connected with Financial Instruments
Rigensis Bank AS Information on the Characteristics of Financial Instruments and the Risks Connected with Financial Instruments Contents 1. Risks connected with the type of financial instrument... 2 Credit
More informationSimple Interest. and Simple Discount
CHAPTER 1 Simple Interest and Simple Discount Learning Objectives Money is invested or borrowed in thousands of transactions every day. When an investment is cashed in or when borrowed money is repaid,
More informationCoupon Bonds and Zeroes
Coupon Bonds and Zeroes Concepts and Buzzwords Coupon bonds Zerocoupon bonds Bond replication Noarbitrage price relationships Zero rates Zeroes STRIPS Dedication Implied zeroes Semiannual compounding
More informationFNCE 301, Financial Management H Guy Williams, 2006
REVIEW We ve used the DCF method to find present value. We also know shortcut methods to solve these problems such as perpetuity present value = C/r. These tools allow us to value any cash flow including
More informationDerivative Users Traders of derivatives can be categorized as hedgers, speculators, or arbitrageurs.
OPTIONS THEORY Introduction The Financial Manager must be knowledgeable about derivatives in order to manage the price risk inherent in financial transactions. Price risk refers to the possibility of loss
More informationFinance 436 Futures and Options Review Notes for Final Exam. Chapter 9
Finance 436 Futures and Options Review Notes for Final Exam Chapter 9 1. Options: call options vs. put options, American options vs. European options 2. Characteristics: option premium, option type, underlying
More informationWeb. Chapter FINANCIAL INSTITUTIONS AND MARKETS
FINANCIAL INSTITUTIONS AND MARKETS T Chapter Summary Chapter Web he Web Chapter provides an overview of the various financial institutions and markets that serve managers of firms and investors who invest
More information15.433 Investments. Assignment 1: Securities, Markets & Capital Market Theory. Each question is worth 0.2 points, the max points is 3 points
Assignment 1: Securities, Markets & Capital Market Theory Each question is worth 0.2 points, the max points is 3 points 1. The interest rate charged by banks with excess reserves at a Federal Reserve Bank
More information2. How is a fund manager motivated to behave with this type of renumeration package?
MØA 155 PROBLEM SET: Options Exercise 1. Arbitrage [2] In the discussions of some of the models in this course, we relied on the following type of argument: If two investment strategies have the same payoff
More informationClick Here to Buy the Tutorial
FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin534/fin534week4quiz3 str/ For more course tutorials visit www.tutorialoutlet.com Which of the following
More informationCHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS
1 CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS (f) 1 The three step valuation process consists of 1) analysis of alternative economies and markets, 2) analysis of alternative industries
More informationHedging Using Forward Contracts
10 CHAPTER 1 Business Snapshot1.1 Hedge Funds Hedge funds have become major users of derivatives for hedging, speculation, and arbitrage. A hedge fund is similar to a mutual fund in that it invests funds
More informationCHAPTER 11 CURRENCY AND INTEREST RATE FUTURES
Answers to endofchapter exercises ARBITRAGE IN THE CURRENCY FUTURES MARKET 1. Consider the following: Spot Rate: $ 0.65/DM German 1yr interest rate: 9% US 1yr interest rate: 5% CHAPTER 11 CURRENCY
More informationBond Mutual Funds. a guide to. A bond mutual fund is an investment company. that pools money from shareholders and invests
a guide to Bond Mutual Funds A bond mutual fund is an investment company that pools money from shareholders and invests primarily in a diversified portfolio of bonds. Table of Contents What Is a Bond?...
More informationInterest Rate Futures. Chapter 6
Interest Rate Futures Chapter 6 1 Day Count Convention The day count convention defines: The period of time to which the interest rate applies. The period of time used to calculate accrued interest (relevant
More informationMargin Requirements & Margin Calls
Margin Requirements & Margin Calls Dr. Patrick Toche References : Zvi Bodie, Alex Kane, Alan J. Marcus. Essentials of Investment. McGraw Hill Irwin. Chapter 3 of the BodieKaneMarcus textbook will be
More informationFIXEDINCOME SECURITIES. Chapter 11. Forwards and Futures
FIXEDINCOME SECURITIES Chapter 11 Forwards and Futures Outline Futures and Forwards Types of Contracts Trading Mechanics Trading Strategies Futures Pricing Uses of Futures Futures and Forwards Forward
More informationOption Values. Determinants of Call Option Values. CHAPTER 16 Option Valuation. Figure 16.1 Call Option Value Before Expiration
CHAPTER 16 Option Valuation 16.1 OPTION VALUATION: INTRODUCTION Option Values Intrinsic value  profit that could be made if the option was immediately exercised Call: stock price  exercise price Put:
More informationSolutions to Practice Questions (Bonds)
Fuqua Business School Duke University FIN 350 Global Financial Management Solutions to Practice Questions (Bonds). These practice questions are a suplement to the problem sets, and are intended for those
More informationUnderstanding Margin and Its Risks
Understanding Margin and Its Risks www.siebertnet.com Before opening a margin account, you should have a clear understanding of the basic facts about margin and the risks of trading securities on margin.
More informationSingle Stock Futures
Single Stock Futures Single Stock Futures (or Individual Equity Futures) are exchange traded derivative instruments offering investors amplified exposure to price movements in a wide array of listed shares.
More informationRISK DISCLOSURE STATEMENT FOR SECURITY FUTURES CONTRACTS
RISK DISCLOSURE STATEMENT FOR SECURITY FUTURES CONTRACTS This disclosure statement discusses the characteristics and risks of standardized security futures contracts traded on regulated U.S. exchanges.
More informationINTEREST RATE SWAP (IRS)
INTEREST RATE SWAP (IRS) 1. Interest Rate Swap (IRS)... 4 1.1 Terminology... 4 1.2 Application... 11 1.3 EONIA Swap... 19 1.4 Pricing and Mark to Market Revaluation of IRS... 22 2. Cross Currency Swap...
More informationAmerican Options. An Undergraduate Introduction to Financial Mathematics. J. Robert Buchanan. J. Robert Buchanan American Options
American Options An Undergraduate Introduction to Financial Mathematics J. Robert Buchanan 2010 Early Exercise Since American style options give the holder the same rights as European style options plus
More informationLecture 5: Forwards, Futures, and Futures Options
OPTIONS and FUTURES Lecture 5: Forwards, Futures, and Futures Options Philip H. Dybvig Washington University in Saint Louis Spot (cash) market Forward contract Futures contract Options on futures Copyright
More informationFIN40008 FINANCIAL INSTRUMENTS SPRING 2008
FIN40008 FINANCIAL INSTRUMENTS SPRING 2008 Options These notes consider the way put and call options and the underlying can be combined to create hedges, spreads and combinations. We will consider the
More information3. If an individual investor buys or sells a currently owned stock through a broker, this is a primary market transaction.
Spring 2012 Finance 3130 Sample Exam 1A Questions for Review 1. The form of organization for a business is an important issue, as this decision has very significant effect on the income and wealth of the
More informationLecture 15: Final Topics on CAPM
Lecture 15: Final Topics on CAPM Final topics on estimating and using beta: the market risk premium putting it all together Final topics on CAPM: Examples of firm and market risk Shorting Stocks and other
More informationMechanics of an Overseas Trade
Interactive Brokers presents Mechanics of an Overseas Trade Andrew Wilkinson, Interactive Brokers Webinar begins @ 12:00 pm EST webinars@interactivebrokers.com www.ibkr.com/webinars Member SIPC www.sipc.org
More informationFinance 400 A. Penati  G. Pennacchi. Option Pricing
Finance 400 A. Penati  G. Pennacchi Option Pricing Earlier we derived general pricing relationships for contingent claims in terms of an equilibrium stochastic discount factor or in terms of elementary
More informationMargin and Exposure 14878.0351 348939.487 34598.6325 66875.0449
14878.0351 348939.487 34598.6325 66875.0449 34838.0371 34898.5321 94898.6327 54798.0321 44898.0324 54695.3522 96898.0321 24848.6323 44898.0321 34898.0328 14878.0351 348939.487 34598.6325 66875.0449 34838.0371
More informationMargin Requirements & Margin Calls
Margin Requirements & Margin Calls Dr. Patrick Toche References : Zvi Bodie, Alex Kane, Alan J. Marcus. Essentials of Investment. McGraw Hill Irwin. Chapter 3 of the BodieKaneMarcus textbook will be
More informationAnalysis of Deterministic Cash Flows and the Term Structure of Interest Rates
Analysis of Deterministic Cash Flows and the Term Structure of Interest Rates Cash Flow Financial transactions and investment opportunities are described by cash flows they generate. Cash flow: payment
More information9 Basics of options, including trading strategies
ECG590I Asset Pricing. Lecture 9: Basics of options, including trading strategies 1 9 Basics of options, including trading strategies Option: The option of buying (call) or selling (put) an asset. European
More informationOption pricing. Vinod Kothari
Option pricing Vinod Kothari Notation we use this Chapter will be as follows: S o : Price of the share at time 0 S T : Price of the share at time T T : time to maturity of the option r : risk free rate
More informationFIN 684 FixedIncome Analysis From Repos to Monetary Policy. Funding Positions
FIN 684 FixedIncome Analysis From Repos to Monetary Policy Professor Robert B.H. Hauswald Kogod School of Business, AU Funding Positions Shortterm funding: repos and money markets funding trading positions
More informationOption Valuation. Chapter 21
Option Valuation Chapter 21 Intrinsic and Time Value intrinsic value of inthemoney options = the payoff that could be obtained from the immediate exercise of the option for a call option: stock price
More information