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Introduction to Derivatives

ISBN: 9780030244834 | 0030244838
Edition: 4th
Format: Paperback
Publisher: South-Western College Pub
Pub. Date: 11/1/1997

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Table of Contents
CHAPTER 1 INTRODUCTION
2(25)
An Overview of the Economic/Financial System
3(2)
... MORE
The Market for Real Assets and Services
3(1)
The Market for Financial Assets
3(1)
International Market Integration
4(1)
Derivative Markets
5(3)
Options
5(1)
Foreward Contracts
6(1)
Futures Contracts
6(1)
Options on Futures
7(1)
Swaps and Other Derivatives
7(1)
Some Important Concepts in Financial and Derivative Markets
8(4)
Risk Preference
8(1)
Short Selling
9(1)
Return and Risk
9(2)
Market Efficiency and Theoretical Fair Value
11(1)
Fundamental Linkages between Spot and Derivative Markets
12(3)
Arbitrage and the Law of One Price
12(2)
The Storage Mechanism: Spreading Consumption across Time
14(1)
Delivery and Settlement
15(1)
The Role of Derivative Markets
15(2)
Risk Management
15(1)
Price Discovery
16(1)
Operational Advantages
16(1)
Market Efficiency
17(1)
Criticisms of Derivative Markets
17(1)
Misuses of Derivatives
18(1)
Derivatives and Your Career
19(1)
Summary
19(2)
Key Terms
20(1)
Questions and Problems
20(1)
Appendix 1: Sources of Information on Derivatives
21(6)
Specialized Trade Publications
21(1)
Gerneral Finance Academic Journals
22(1)
Academic-Practitioner Finance Journals
22(1)
Specialized Derivatives Journals
23(1)
World Wide Web and Internet Sites
23(1)
Other Sources
24(3)
Part One OPTIONS27(236)
CHAPTER 2 THE STRUCTURE OF OPTIONS MARKETS
28(44)
The Development of Options Markets
29(2)
Call Options
31(1)
Put Options
32(1)
The Over-the-Counter Options Market
32(2)
Organized Options Trading
34(4)
Listing Requirements
35(1)
Contract Size
35(1)
Exercise Prices
36(1)
Expiration Dates
37(1)
Position and Exercise Limits
38(1)
Exchanges on which Options Trade
38(2)
Option Traders
40(6)
The Market Maker
41(1)
The Floor Broker
42(1)
The Order Book Official
43(1)
Other Option Trading Systems
43(1)
Off-Floor Option Traders
44(1)
Cost and Profitability of Exchange Membership
44(2)
The Mechanics of Trading
46(5)
Placing an Opening Order
46(1)
The Role of the Clearinghouse
47(2)
Placing an Offsetting Order
49(1)
Exercising an Option
50(1)
Option Price Quotations
51(4)
Types of Options
55(3)
Stock Options
55(1)
Index Options
55(2)
Other Types of Options
57(1)
Indices of Options Market Activity
58(1)
Transaction Costs in Option Trading
58(3)
Floor Trading and Clearing Fees
58(1)
Commissions
59(1)
Bid-Ask Spread
60(1)
Other Transaction Costs
61(1)
The Regulation of Options Markets
61(2)
Summary
63(2)
Key Terms
63(1)
Questions and Problems
63(2)
Appendix 2A: Margin Requirements
65(2)
Margin Requirements on Stock Transactions
65(1)
Margin Requirements on Option Purchases
65(1)
Margin Requirements on the Uncovered Sale of Options
66(1)
Margin Requirements on Covered Calls
66(1)
Questions and Problems
67(1)
Appendix 2B: Taxation of Option Transactions
67(5)
Taxation of Long Call Transactions
68(1)
Taxation of Short Call Transactions
68(1)
Taxation of Long Put Transactions
69(1)
Taxation of Short Put Transactions
69(1)
Taxation of Non-Equity Options
70(1)
The Wash Sale Rule: A Special Consideration
70(1)
Questions and Problems
71(1)
CHAPTER 3 PRINCIPLES OF OPTION PRICING
72(42)
Basic Notation and Terminology
73(3)
Principles of Call Option Pricing
76(16)
The Minimum Value of a Call
76(3)
The Maximum Value of a Call
79(1)
The Value of a Call at Expiration
79(1)
The Effect of Time to Expiration
79(4)
The Effect of Exercise Price
83(3)
The Lower Bound of a European Call
86(3)
American Call versus European Call
89(1)
The Early Exercise of American Calls on Dividend-Paying Stocks
90(1)
The Effect of Interest Rates
91(1)
The Effect of Stock Volatility
92(1)
Principles of Put Option Pricing
92(16)
The Minimum Value of a Put
93(1)
The Maximum Value of a Put
93(2)
The Value of a Put at Expiration
95(1)
The Effect of Time to Expiration
95(3)
The Effect of Exercise Price
98(2)
The Lower Bound of a European Put
100(3)
American Put versus European Put
103(1)
The Early Exercise of American Puts
103(1)
Put-Call Parity
104(2)
The Effect of Interest Rates
106(1)
The Effect of Stock Volatility
107(1)
Summary
108(6)
Key Terms
111(1)
Questions and Problems
111(3)
CHAPTER 4 OPTION PRICING MODELS
114(64)
The One-Period Binomial Model
115(7)
An Illustrative Example
119(1)
A Hedged Portfolio
119(2)
An Overpriced Call
121(1)
An Underpriced Call
121(1)
The Two-Period Binomial Model
122(8)
An Illustrative Example
124(1)
A Hedged Portfolio
125(3)
A Mispriced Call in the Two-Period World
128(2)
Some Useful Extensions of the Binomial Model
130(3)
Pricing Put Options
130(1)
American Options and Early Exercise
130(3)
The Black-Scholes Option Pricing Model
133(6)
The Normal Distribution
134(1)
A Numerical Example
135(4)
The Variables in the Black-Scholes Model
139(8)
The Stock Price
139(4)
The Exercise Price
143(1)
The Risk-Free Rate
143(1)
The Variance or Standard Deviation
144(2)
The Time to Expiration
146(1)
The Black-Scholes Model in the Presence of Dividends
147(3)
Known Discrete Dividends
148(1)
Continuous Dividend Yield
149(1)
American Options
150(2)
Estimating the Volatility (Standard Deviation)
152(7)
Historical Volatility
152(3)
Implied Volatility
155(4)
The Binomial Model and the Black-Scholes Model
159(3)
Put Option Pricing Models
162(5)
Early Exercise of an American Put
163(4)
Summary
167(5)
Key Terms
168(1)
Questions and Problems
169(3)
Appendix 4A: The N-Period Binomial Model
172(1)
Appendix 4B: A Shortcut to the Calculation of Implied Volatility
173(1)
Appendix 4C: The BSBWIN2 Windows Software
174(4)
CHAPTER 5 BASIC OPTION STRATEGIES
178(44)
Terminology and Notation
179(4)
The Profit Equations
180(1)
Different Holding Periods
181(1)
Assumptions
182(1)
Stock Transactions
183(1)
Buy Stock
183(1)
Sell Short Stock
183(1)
Call Option Transactions
184(9)
Buy a Call
185(5)
Write a Call
190(3)
Put Option Transactions
193(7)
Buy a Put
193(4)
Write a Put
197(3)
Calls and Stock: The Covered Call
200(7)
Some General Considerations with Covered Calls
206(1)
Puts and Stock: The Protective Put
207(5)
Synthetic Puts and Calls
212(3)
Summary
215(7)
Key Terms
219(1)
Questions and Problems
219(3)
CHAPTER 6 ADVANCED OPTION STRATEGIES
222(41)
Option Spreads: Basic Concepts
222(3)
Why Investors Use Option Spreads
223(1)
Notation
224(1)
Money Spreads
225(12)
Bull Spreads
225(4)
Bear Spreads
229(3)
A Word about Put Money Spreads
232(1)
Calendar Spreads
237(5)
Ratio Spreads
242(1)
Straddles, Straps, and Strips
243(15)
Applications of Straddles
248(1)
A Short Straddle
249(1)
Straps
249(3)
Strips
252(2)
Box Spreads
254(4)
Summary
258(5)
Key Terms
258(1)
Questions and Problems
258(5)
Part Two FORWARDS AND FUTURES263(234)
CHAPTER 7 THE STRUCTURE OF FORWARD AND FUTURES MARKETS
264(54)
The Development of Forward and Futures Markets
266(3)
Chicago Futures Markets
266(1)
The Development of Financial Futures
267(1)
The Parallel Development of Over-the-Counter Markets
268(1)
The Over-the-Counter Forward Market
269(1)
Organized Futures Trading
270(3)
Contract Development
270(1)
Contract Terms and Conditions
271(1)
Delivery Terms
272(1)
Daily Price Limits and Trading Halts
272(1)
Other Exchange Responsibilities
273(1)
Futures Exchanges
273(5)
Futures Traders
278(6)
General Classes of Futures Traders
278(1)
Classification by Trading Strategy
279(1)
Classification by Trading Style
280(1)
Off-Floor Futures Traders
281(1)
The Cost and Profitability of Exchange Membership
281(2)
Forward Market Traders
283(1)
The Mechanics of Futures Trading
284(8)
Placing an Order
284(1)
The Role of the Clearinghouse
285(1)
Daily Settlement
286(4)
Delivery and Cash Settlement
290(2)
Futures Price Quotations
292(2)
Types of Futures Contracts
294(11)
Grains and Oilseeds
294(1)
Livestock and Meat
295(2)
Food and Fiber
297(1)
Metals and Energy
297(1)
Miscellaneous
297(1)
Foreign Currency
297(1)
Treasury Bills and Eurodollars
297(2)
Treasury Notes and Bonds
299(4)
Economic Indices
303(1)
Stock Indices
303(1)
Managed Futures
304(1)
Indices of Futures Market Activity
305(1)
Transaction Costs in Forward and Futures Trading
305(2)
Commissions
306(1)
Bid-Ask Spread
306(1)
Delivery Costs
306(1)
The Regulation of Futures Markets
307(2)
Early Federal Regulation
307(1)
The Commodity Futures Trading Commission
307(2)
The National Futures Association
309(1)
Summary
309(4)
Key Terms
310(1)
Questions and Problems
310(3)
Appendix 7A: Selected Financial Futures Contract Specifications
313(1)
Appendix 7B: Taxation of Futures Transactions
314(1)
Appendix 7C: Determining the CBOT Treasury Bond Conversion Factor
315(3)
CHAPTER 8 PRINCIPLES OF SPOT PRICING
318(47)
Principles and Pricing of Fixed-Income Securities
318(27)
The Concept of Spot and Forward Rates
318(1)
The Relationship between Spot and Forward Rates
319(3)
Theories of the Term Structure
322(3)
The Pricing of Bonds
325(4)
The Relationship between Bond Prices and Yields
329(5)
Duration
334(5)
The Term Structure and the Yield Curve
339(1)
Estimating the Term Structure
340(5)
Principles and Pricing of Equity Securities
345(10)
Portfolio Theory
345(2)
Asset Pricing Theory
347(2)
Measuring Systematic Risk
349(3)
Equity Market Indices
352(3)
The Formation of Spot Prices
355(6)
The Spot Pricing Model under Certainty
356(1)
The Spot Pricing Model under Uncertainty
356(3)
A Further Word on Storage
359(2)
Summary
361(4)
Key Terms
362(1)
Questions and Problems
362(3)
CHAPTER 9 PRINCIPLES OF FORWARD AND FUTURES PRICING
365(41)
Some Properties of Forward and Futures Prices
366(16)
The Concept of Price versus Value
366(1)
The Value of a Forward Contract
367(3)
The Value of a Futures Contract
370(2)
Forward versus Futures Prices
372(10)
A Forward and Futures Pricing Model
382(19)
The Theoretical Fair Price
383(6)
Futures Prices and Risk Premia
389(6)
The Effect of Intermediate Cash Flows
395(4)
Prices of Futures Contracts of Different Expirations
399(2)
Summary
401(5)
Key Terms
403(1)
Questions and Problems
403(3)
CHAPTER 10 FUTURES HEDGING STRATEGIES
406(48)
Why Hedge?
406(2)
Hedging Concepts
408(12)
Short Hedge and Long Hedge
408(1)
The Basis
409(6)
Some Risks of Hedging
415(1)
Contract Choice
416(2)
Margin Requirements and Marking to Market
418(2)
Determination of the Hedge Ratio
420(6)
Minimum Variance Hedge Ratio
421(2)
Price Sensitivity Hedge Ratio
423(1)
Stock Index Futures Hedging
424(1)
Tailing the Hedge
425(1)
Hedging Strategies
426(19)
Short-Term Interest Rate Hedges
428(8)
Intermediate-and Long-Term Interest Rate Futures Hedges
436(5)
Stock Index Futures Hedges
441(4)
Summary
445(6)
Key Terms
446(1)
Questions and Problems
446(5)
Appendix 10A: Derivation of the Hedge Ratio
451(1)
Minimum Variance Hedge Ratio
451(1)
Price Sensitivity Hedge Ratio
451(1)
Appendix 10B: Taxation of Hedging
452(2)
CHAPTER 11 ADVANCED FUTURES STRATEGIES
454(43)
Short-Term Interest Rate Futures Strategies
455(5)
Treasury Bill Cash-and-Carry/Implied Repo
455(2)
Eurodollar Arbitrage
457(3)
Intermediate-and Long-Term Interest Rate Futures Strategies
460(18)
Determining the Cheapest-to-Deliver Bond on the Treasury Bond Futures Contract
460(3)
Delivery Options
463(6)
Implied Repo/Cost of Carry
469(2)
A Treasury Bond Futures Spread
471(1)
Treasury Bond Spread/Implied Repo Rate
471(3)
Intermarket Spreads
474(1)
Bond Market Timing with Futures
475(3)
Stock Index Futures Strategies
478(13)
Stock Index Arbitrage
478(5)
Speculating on Unsystematic Risk
483(1)
Stock Market Timing with Futures
484(3)
Arbitraging Stock Index Futures with Stock Index Options
487(4)
Summary
491(4)
Key Terms
491(1)
Questions and Problems
492(3)
Appendix 11A: Derivation of the Hedge Ratio for Adjusting Duration with Treasury Bond Futures
495(2)
Part Three ADVANCED TOPICS497(234)
CHAPTER 12 OPTIONS ON FUTURES
499(30)
Characteristics of Options on Futures
499(3)
Pricing Options on Futures
502(15)
The Intrinsic Value of an American Option on Futures
505(1)
The Lower Bound of a European Option on Futures
506(3)
Put-Call Parity of Options on Futures
509(1)
Early Exercise of Call and Put Options on Futures
510(2)
The Black Option on Futures Pricing Model
512(5)
Trading Strategies for Options on Futures
517(5)
Buy a Call Option on Futures
518(1)
Buy a Put Option on Futures
519(1)
Write a Covered Call Option on Futures
520(2)
Options on Futures versus Options on the Spot
522(2)
Summary
524(4)
Key Terms
525(1)
Questions and Problems
526(2)
Appendix 12A: Selected Options on Futures Contract Specifications
528(1)
CHAPTER 13 FOREIGN CURRENCY DERIVATIVES
529(42)
Characteristics of Foreign Currencies and Markets
529(11)
The Nature of Exchange Rates
529(1)
A Brief History of Foreign Currency Markets
530(3)
Foreign Currency Spot and Forward Markets
533(1)
Foreign Currency Futures Markets
534(1)
Foreign Currency Options Markets
535(5)
Pricing Foreign Currency Derivatives
540(11)
Cross-Rate Relationships
540(1)
Interest Rate Parity
541(3)
The Intrinsic Value of an American Foreign Currency Option
544(1)
The Lower Bound of European Foreign Currency Options
544(3)
Put-Call Parity
547(2)
The Garman-Kohlhagen Foreign Currency Option Pricing Model
549(2)
Trading Strategies in Foreign Currency Futures/Forwards and Options
551(8)
A Long Hedge with Foreign Currency Futures
551(1)
A Short Hedge with Foreign Currency Forwards
552(1)
Buy a Foreign Currency Call
553(2)
Buy a Foreign Currency Put
555(1)
A Foreign Currency Option Hedge
556(3)
Other Instruments for Managing Foreign Exchange Risk
559(6)
Options on Foreign Currency Futures
560(1)
Currency Swaps
560(4)
Other Currency Derivatives
564(1)
Summary
565(4)
Key Terms
566(1)
Questions and Problems
566(3)
Appendix 13A: Foreign Currency Futures Contract Specifications
569(1)
Appendix 13B: Foreign Currency Options Contract Specifications
570(1)
CHAPTER 14 SWAPS AND OTHER INTEREST RATE AGREEMENTS
571(46)
Forward Rate Agreements
572(3)
Interest Rate Swaps
575(9)
The Structure of an Interest Rate Swap
576(2)
Transactions Equivalent to Interest Rate Swaps
578(1)
Pricing an Interest Rate Swap at the Onset
579(2)
Pricing an Interest Rate Swap during Its Life
581(2)
Terminating an Interest Rate Swap
583(1)
Interest Rate Options
584(5)
Interest Rate Calls and Puts
584(7)
Interest Rate Caps, Floors, and Collars
591(5)
Interest Rate Swaptions and Forward Swaps
596(3)
Modeling the Term Structure and Pricing Interest Rate Derivatives
599(9)
Pricing Forward Rate Agreements
602(1)
Pricing Interest Rate Swaps
603(1)
Pricing Interest Rate Options
604(2)
Pricing Swaptions
606(2)
Summary
608(5)
Key Terms
609(1)
Questions and Problems
610(3)
Appendix 14A: The Ho-Lee Model of the Term Structure
613(4)
CHAPTER 15 ADVANCED DERIVATIVES AND STRATEGIES
617(53)
Advanced Equity Derivatives and Strategies
617(18)
Portfolio Insurance
618(7)
Equity Forwards
625(2)
Equity Swaps
627(4)
Equity Collars
631(2)
Equity Warrants
633(1)
Equity-Linked Debt
634(1)
Advanced Interest Rate Derivatives
635(11)
Variations of Interest Rate Swaps
635(4)
Structured Notes
639(2)
Mortgage-Backed Securities
641(5)
Exotic Options
646(13)
Digital and Chooser Options
647(2)
Path-Dependent Options
649(9)
Other Exotic Options
658(1)
Summary
659(6)
Key Terms
660(1)
Questions and Problems
661(4)
Appendix 15A: Derivation of the Dynamic Hedge Ratio for Portfolio Insurance
665(2)
Stock-Futures Dynamic Hedge
665(1)
Stock-T-Bill Dynamic Hedge
666(1)
Appendix 15B: Monte Carlo Simulation
667(3)
CHAPTER 16 FINANCIAL RISK MANAGEMENT
670(61)
Why Practice Risk Management?
672(5)
The Impetus for Risk Management
672(2)
The Benefits of Risk Management
674(3)
The Structure of the Risk Management Industry
677(4)
End Users
677(1)
Dealers
678(2)
Other Participants in the Risk Management Industry
680(1)
Managing Market Risk
681(17)
Delta Hedging
683(3)
Gamma Hedging
686(2)
Vega Hedging
688(3)
Value at Risk (VaR)
691(7)
Managing Credit Risk
698(5)
Netting
701(2)
Other Types of Risks
703(2)
Organizational Issues in Risk Management
705(7)
Some Lessons in Risk Management
712(12)
Metallgesellschaft: To Hedge or Not to Hedge
712(6)
Orange County, California: Playing the Odds
718(2)
Barings PLC: How One Man Blew Up a Bank
720(3)
Procter & Gamble: Going Up in Suds
723(1)
Summary
724(7)
Key Terms
726(1)
Questions and Problems
727(4)
APPENDIX A LIST OF SYMBOLS731(4)
APPENDIX B LIST OF FORMULAS735(9)
APPENDIX C REFERENCES744(11)
GLOSSARY755(22)
INDEX777

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