Derivatives and risk management

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Cover Half Title About the Author Title Page Copyright Preface Acknowledgements Contents Chapter 1. INTRODUCTION TO DERIVATIVES 1.1 What are Derivatives and What Do they Do? 1.2 Development and Growth of Derivative Markets 1.3 Types of Derivatives 1.4 Uses of Derivatives 1.5 Derivative Disasters 1.6 Overview of the Book Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 2. FORWARD AND FUTURES MARKETS 2.1 Forward Contracts 2.2 Differences between Forward and Spot Market 2.3 Futures Contracts 2.4 Futures Market Contract Design 2.5 Physical Settlement, Delivery Options and Cash Settlement 2.6 Futures Markets 2.7 Global Futures Market Size 2.8 Commodity Futures 2.9 Individual Equity Futures 2.10 Stock Index Futures 2.11 Currency Futures 2.12 Futures on Government Bonds, Notes and Bills 2.13 Cash Settled Interest Rate Futures Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 3. COST OF CARRY MODEL FOR FUTURES AND FORWARDS 3.1 A Simple Example 3.2 Cash and Carry Arbitrage 3.3 Reverse Cash and Carry Arbitrage 3.4 The Cost of Carry Model 3.5 The Cost of Carry Model with Continuous Compounding 3.6 Consumption Assets and Convenience Yields 3.7 Value of a Forward Contract 3.8 Relation between Futures and Expected Spot Prices 3.9 Backwardation and Contango Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 4. RISK MANAGEMENT USING FUTURES AND FORWARDS 4.1 Perfect Hedges and Known Exposures 4.2 Basis Risk and Optimal Hedge Ratio 4.3 Measuring Risk Exposure 4.4 Use of Betas in Index Future Hedges 4.5 Use of Modified Duration in Interest Rate Hedges 4.6 Hedging Currency Risk of Equity Positions 4.7 Tailing the Hedge 4.8 Rolling Hedges Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 5. HOW AND WHY DO FIRMS HEDGE? 5.1 Costs and Benefits of Hedging 5.2 Hedging Instruments 5.3 Non-financial Hedges 5.4 Risk Management Structures and Policies Chapter Summary Suggestions for Further Reading Cases Chapter 6. OPTIONS AND THEIR PAYOFFS 6.1 European and American Calls and Puts 6.2 Payoff and Profit Diagrams 6.3 Options as Insurance 6.4 Determinants of Option Price 6.5 Bounds on Option Price 6.6 Put Call Parity Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 7. OPTION MARKETS 7.1 Exchange Traded Options and OTC Options 7.2 Options Market Contract Design 7.3 Option Exercise, Settlement, and Assignment 7.4 Options Markets 7.5 Commodity Options 7.6 Stock Index Options 7.7 Individual Equity Options 7.8 Currency Options 7.9 Interest Rate and Bond Options Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 8. RISK NEUTRAL VALUATION 8.1 Risk Adjusted Discount Rates and Certainty Equivalents 8.2 Risk-neutral Probabilities 8.3 Cost of Carry Model Revisited 8.4 Expected Utility Derivation of Risk-neutral Probabilities 8.5 No Arbitrage and Risk-neutral Probabilities—Single Period 8.6 No Arbitrage and Risk-neutral Probabilities—Multiple Periods 8.7 Risk-neutral Valuation in Continuous Time Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 9. THE BINOMIAL OPTION PRICING MODEL 9.1 Single Step Binomial 9.2 Option Delta and Delta Hedging 9.3 Multi Period Binomial Trees 9.4 Option Deltas in the Multi Period Model 9.5 Matching Volatility and Risk-free Rate 9.6 More Examples of Binomial Trees 9.7 Binomial Model for American Options 9.8 Binomial Trees and the Log Normal Distribution Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 10. THE BLACK-SCHOLES OPTION PRICING MODEL 10.1 The Model of Stock Price Behaviour 10.2 The Log Normal Distribution 10.3 The Risk Neutral Log Normal Distribution 10.4 The Black-Scholes Formula 10.5 Black-Scholes Model With Dividends 10.6 Options on Stock Indices 10.7 Options on Currencies 10.8 Options on Futures 10.9 Options on Commodities 10.10 American Options 10.11 Appendix on Log Normal Distribution Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 11. USES OF OPTIONS: SIMPLE OPTION STRATEGIES 11.1 Buying Options Instead of Trading Forwards or Spot 11.2 Range Forwards 11.3 Bull and Bear Spreads 11.4 Covered Option Writing Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 12. THE GREEKS OF THE BLACK-SCHOLES MODEL 12.1 Delta 12.2 Gamma 12.3 Theta 12.4 The Black-Scholes Equation 12.5 Vega 12.6 RHO 12.7 Numerical Example of Option Greeks Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 13. COMPLEX OPTION STRATEGIES 13.1 Straddles 13.2 Strangles 13.3 Butterfly Spreads 13.4 Greeks of Option Strategies 13.5 Calendar Spreads Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 14 VOLATILITIES AND IMPLIED VOLATILITIES 14.1 Historical Volatility 14.2 Exponentially Weighted Moving Averages 14.3 Garch Method 14.4 Implied Volatility Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 15. VOLATILITY SMILES AND IMPLIED RISK NEUTRAL DISTRIBUTIONS 15.1 Revisiting the Black-Scholes Formula 15.2 Volatility Smile and the Risk-neutral Distribution 15.3 Option Combinations and Volatility Smiles 15.4 Term Structure of Volatility 15.5 Volatility Surfaces 15.6 Implications of Stochastic Volatility 15.7 Implications of Volatility Surfaces for Hedging and Option Greeks Chapter Summary Suggestions for Further Reading Additional Suggestions for Further Reading Problems and Questions Chapter 16. EXOTIC OPTIONS 16.1 Digital or Binary Options 16.2 Barrier Options 16.3 Asian Options 16.4 Chooser Options 16.5 Compound Options 16.6 Other Exotic Options Chapter Summary Suggestions for Further Reading Problems and Questions Chapter 17. WARRANTS AND CONVERTIBLES 17.1 Warrants 17.2 The Warrant Valuation Model 17.3 Employee Stock Options 17.4 Convertible Bonds as Straight Bonds Plus Warrants 17.5 Convertible Bonds: Risk Neutral Valuation of All Cash Flows 17.6 Convertible Bond Valuation with Interest Rate Uncertainty Chapter Summary Suggestions for Further Reading Cases Chapter 18. INTEREST RATE AND CURRENCY SWAPS 18.1 The Swap Markets 18.2 Using Swaps to Hedge Interest Rate and Currency Risk 18.3 Interest Rate Swap As Exchange of Floating Rate Bond for Fixed Rate Bond 18.4 Valuing Floating Rate Bonds 18.5 Valuing Fixed Rate Bonds using Yield to Maturity (YTM) 18.6 Zero Rates and Forward Rates 18.7 Interest Rate Swap as Bundle of Forward Contracts 18.8 Currency Swaps as Exchange of Bonds 18.9 Currency Swaps as Bundle of Forward Contracts Chapter Summary Suggestions for Further Reading Case on Swaps Chapter 19. CAPS, FLOORS AND SWAPTIONS 19.1 Caps and Floors 19.2 The Libor Market Model (LMM) for Cap and Floor Valuation 19.3 Caplet and Cap Volatilities 19.4 Swaptions and Callable Bonds 19.5 The Swap Market Model for Valuing Swaptions 19.6 Swaption Volatilities 19.7 Risk Neutral Valuation of Interest Rate Derivatives 19.8 Reconciling Lognormality Assumption for Caps and Swaptions Chapter Summary Suggestions for Further Reading Chapter 20. DERIVATIVE ACCOUNTING 20.1 Introduction to Derivatives Accounting 20.2 Derivatives and Fair Value Accounting 20.3 Hedge Accounting 20.4 Requirements for Hedge Accounting Chapter Summary Suggestions for Further Reading Cases Chapter 21. CORPORATE RISK MANAGEMENT 21.1 Risk Management and Shareholder Value 21.2 Lenders, Employees and Other Stakeholders 21.3 Planning and Control Reasons for Hedging 21.4 Financial Distress 21.5 Cash Flow Hedges and Value Hedges 21.6 Capital Structure and Hedging 21.7 Is the Risk Department a Profit Centre or a Cost Centre? Chapter Summary Suggestions for Further Reading Cases Chapter 22. RISK MANAGEMENT IN FINANCIAL INSTITUTIONS 22.1 Value at Risk 22.2 Historical Simulation 22.3 Delta-Normal Approximation 22.4 Delta-Gamma Approximation 22.5 Monte Carlo Simulation 22.6 Modelling and Estimating Correlations 22.7 Back Testing 22.8 Stress Testing 22.9 Internal Control Systems 22.10 Regulatory Considerations Chapter Summary Suggestions for Further Reading Index