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Pirie Wendy L.. Derivatives
FOREWORD
PREFACE
THE CFA PROGRAM
CFA INSTITUTE
ACKNOWLEDGMENTS
ABOUT THE CFA INSTITUTE INVESTMENT SERIES
The Texts
CHAPTER 1. DERIVATIVE MARKETS AND INSTRUMENTS
LEARNING OUTCOMES
1. INTRODUCTION
2. DERIVATIVES: DEFINITIONS AND USES
3. THE STRUCTURE OF DERIVATIVE MARKETS
3.1. Exchange-Traded Derivatives Markets
3.2. Over-the-Counter Derivatives Markets
4. TYPES OF DERIVATIVES
4.1. Forward Commitments
4.2. Contingent Claims
4.3. Hybrids
4.4. Derivatives Underlyings
5. THE PURPOSES AND BENEFITS OF DERIVATIVES
5.1. Risk Allocation, Transfer, and Management
5.2. Information Discovery
5.3. Operational Advantages
5.4. Market Efficiency
6. CRITICISMS AND MISUSES OF DERIVATIVES
6.1. Speculation and Gambling
6.2. Destabilization and Systemic Risk
7. ELEMENTARY PRINCIPLES OF DERIVATIVE PRICING
7.1. Storage
7.2. Arbitrage
8. SUMMARY
PROBLEMS
CHAPTER 2. BASICS OF DERIVATIVE PRICING AND VALUATION
LEARNING OUTCOMES
1. INTRODUCTION
2. FUNDAMENTAL CONCEPTS OF DERIVATIVE PRICING
2.1. Basic Derivative Concepts
2.2. Pricing the Underlying
2.3. The Principle of Arbitrage
2.4. The Concept of Pricing versus Valuation
3. PRICING AND VALUATION OF FORWARD COMMITMENTS
3.1. Pricing and Valuation of Forward Contracts
3.2. Pricing and Valuation of Futures Contracts
3.3. Pricing and Valuation of Swap Contracts
4. PRICING AND VALUATION OF OPTIONS
4.1. European Option Pricing
4.2. Binomial Valuation of Options
4.3. American Option Pricing
5. SUMMARY
PROBLEMS
CHAPTER 3. PRICING AND VALUATION OF FORWARD COMMITMENTS
LEARNING OUTCOMES
1. INTRODUCTION
2. PRINCIPLES OF ARBITRAGE-FREE PRICING AND VALUATION OF FORWARD COMMITMENTS
3. PRICING AND VALUING FORWARD AND FUTURES CONTRACTS
3.1. Our Notation
3.2. No-Arbitrage Forward Contracts
3.3. Equity Forward and Futures Contracts
3.4. Interest Rate Forward and Futures Contracts
3.5. Fixed-Income Forward and Futures Contracts
3.6. Currency Forward and Futures Contracts
3.7. Comparing Forward and Futures Contracts
4. PRICING AND VALUING SWAP CONTRACTS
4.1. Interest Rate Swap Contracts
4.2. Currency Swap Contracts
4.3. Equity Swap Contracts
5. SUMMARY
PROBLEMS
CHAPTER 4. Valuation of Contingent Claims
LEARNING OUTCOMES
1. INTRODUCTION
2. PRINCIPLES OF A NO-ARBITRAGE APPROACH TO VALUATION
3. BINOMIAL OPTION VALUATION MODEL
3.1. One-Period Binomial Model
3.2. Two-Period Binomial Model
3.3. Interest Rate Options
3.4. Multiperiod Model
4. BLACK–SCHOLES–MERTON OPTION VALUATION MODEL
4.1. Introductory Material
4.2. Assumptions of the BSM Model
4.3. BSM Model
5. BLACK OPTION VALUATION MODEL
5.1. European Options on Futures
5.2. Interest Rate Options
5.3. Swaptions
6. OPTION GREEKS AND IMPLIED VOLATILITY
6.1. Delta
6.2. Gamma
6.3. Theta
6.4. Vega
6.5. Rho
6.6. Implied Volatility
7. SUMMARY
PROBLEMS
CHAPTER 5. DERIVATIVES STRATEGIES
LEARNING OUTCOMES
1. INTRODUCTION
2. CHANGING RISK EXPOSURES WITH SWAPS, FUTURES, AND FORWARDS
2.1. Interest Rate Swap/Futures Examples
2.2. Currency Swap/Futures Examples
2.3. Equity Swap/Futures Examples
3. POSITION EQUIVALENCIES
3.1. Synthetic Long Asset
3.2. Synthetic Short Asset
3.3. Synthetic Assets with Futures/Forwards
3.4. Synthetic Put
3.5. Synthetic Call
3.6. Foreign Currency Options
4. COVERED CALLS AND PROTECTIVE PUTS
4.1. Investment Objectives of Covered Calls
4.2. Investment Objective of Protective Puts
4.3. Equivalence to Long Asset/Short Forward Position
4.4. Writing Cash-Secured Puts
4.5. The Risk of Covered Calls and Protective Puts
4.6. Collars
5. SPREADS AND COMBINATIONS
5.1. Bull Spreads and Bear Spreads
5.2. Calendar Spread
5.3. Straddle
5.4. Consequences of Exercise
6. INVESTMENT OBJECTIVES AND STRATEGY SELECTION
6.1. The Necessity of Setting an Objective
6.2. Spectrum of Market Risk
6.3. Analytics of the Breakeven Price
6.4. Applications
7. SUMMARY
PROBLEMS
CHAPTER 6. RISK MANAGEMENT
LEARNING OUTCOMES
1. INTRODUCTION
2. RISK MANAGEMENT AS A PROCESS
3. RISK GOVERNANCE
4. IDENTIFYING RISKS
4.1. Market Risk
4.2. Credit Risk
4.3. Liquidity Risk
4.4 Operational Risk
4.5. Model Risk
4.6. Settlement (Herstatt) Risk
4.7. Regulatory Risk
4.8. Legal/Contract Risk
4.9. Tax Risk
4.10. Accounting Risk
4.11. Sovereign and Political Risks
4.12. Other Risks
5. MEASURING RISK
5.1. Measuring Market Risk
5.2. Value at Risk
5.3. The Advantages and Limitations of VaR
5.4. Extensions and Supplements to VaR
5.5. Stress Testing
5.6. Measuring Credit Risk
5.7. Liquidity Risk
5.8. Measuring Nonfinancial Risks
6. MANAGING RISK
6.1. Managing Market Risk
6.2. Managing Credit Risk
6.3. Performance Evaluation
6.4. Capital Allocation
6.5. Psychological and Behavioral Considerations
7. SUMMARY
PROBLEMS
REFERENCES
CHAPTER 7. Risk Management Applications of Forward and Futures Strategies
LEARNING OUTCOMES
1. INTRODUCTION
2. STRATEGIES AND APPLICATIONS FOR MANAGING INTEREST RATE RISK
2.1. Managing the Interest Rate Risk of a Loan Using an FRA
2.2. Strategies and Applications for Managing Bond Portfolio Risk
3. STRATEGIES AND APPLICATIONS FOR MANAGING EQUITY MARKET RISK
3.1. Measuring and Managing the Risk of Equities
3.2. Managing the Risk of an Equity Portfolio
3.3. Creating Equity out of Cash
3.4. Creating Cash out of Equity
4. ASSET ALLOCATION WITH FUTURES
4.1. Adjusting the Allocation among Asset Classes
4.2. Pre-Investing in an Asset Class
5. STRATEGIES AND APPLICATIONS FOR MANAGING FOREIGN CURRENCY RISK
5.1. Managing the Risk of a Foreign Currency Receipt
5.2. Managing the Risk of a Foreign Currency Payment
5.3. Managing the Risk of a Foreign-Market Asset Portfolio
6. FUTURES OR FORWARDS?
7. FINAL COMMENTS
8. SUMMARY
PROBLEMS
CHAPTER 8. RISK MANAGEMENT APPLICATIONS OF OPTION STRATEGIES
LEARNING OUTCOMES
1. INTRODUCTION
2. OPTION STRATEGIES FOR EQUITY PORTFOLIOS
2.1. Standard Long and Short Positions
2.2. Risk Management Strategies with Options and the Underlying
2.3. Money Spreads
2.4. Combinations of Calls and Puts
3. INTEREST RATE OPTION STRATEGIES
3.1. Using Interest Rate Calls with Borrowing
3.2. Using Interest Rate Puts with Lending
3.3. Using an Interest Rate Cap with a Floating-Rate Loan
3.4. Using an Interest Rate Floor with a Floating-Rate Loan
3.5. Using an Interest Rate Collar with a Floating-Rate Loan
4. OPTION PORTFOLIO RISK MANAGEMENT STRATEGIES
4.1. Delta Hedging an Option over Time
4.2. Gamma and the Risk of Delta
4.3. Vega and Volatility Risk
5. FINAL COMMENTS
6. SUMMARY
PROBLEMS
CHAPTER 9. RISK MANAGEMENT APPLICATIONS OF SWAP STRATEGIES
LEARNING OUTCOMES
1. INTRODUCTION
2. STRATEGIES AND APPLICATIONS FOR MANAGING NTEREST RATE RISK
2.1. Using Interest Rate Swaps to Convert a Floating-Rate Loan to a Fixed-Rate Loan (and Vice Versa)
2.2. Using Swaps to Adjust the Duration of a Fixed-Income Portfolio
2.3. Using Swaps to Create and Manage the Risk of Structured Notes
3. STRATEGIES AND APPLICATIONS FOR MANAGING EXCHANGE RATE RISK
3.1. Converting a Loan in One Currency into a Loan in Another Currency
3.2. Converting Foreign Cash Receipts into Domestic Currency
3.3. Using Currency Swaps to Create and Manage the Risk of a Dual-Currency Bond
4. STRATEGIES AND APPLICATIONS FOR MANAGING EQUITY MARKET RISK
4.1. Diversifying a Concentrated Portfolio
4.2. Achieving International Diversification
4.3. Changing an Asset Allocation between Stocks and Bonds
4.4. Reducing Insider Exposure
5. STRATEGIES AND APPLICATIONS USING SWAPTIONS
5.1. Using an Interest Rate Swaption in Anticipation of a Future Borrowing
5.2. Using an Interest Rate Swaption to Terminate a Swap
5.3. Synthetically Removing (Adding) a Call Feature in Callable (Noncallable) Debt
5.4. A Note on Forward Swaps
6. CONCLUSIONS
7. SUMMARY
PROBLEMS
GLOSSARY
About the Editors and Authors
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