Table of Contents
Preface
Derivatives-An Introduction
Introduction to Risk
Managing Risk
Types of Business Risks
Price Risk
Exchange Rate Risk
Interest Rate Risk
Derivatives
Principle of Hedging
Derivative Products
Classification of Derivatives
Participants in Derivative Markets
Hedgers
Speculators
Arbitrageurs
Steps for Hedge Accounting
Hedged Item
Hedging Instruments
Hedging Relationship
Functions of Derivative Markets
Misuses and Criticism of Derivatives
2. Forwards and Futures
Introduction
Forward Contract
Features of Forward Contract
Settlement of Forward Contract
Futures Contract
Specifications of Futures Contract
Open Interest
Differences between Forward and Futures Contracts
Margins
Marking to Market
Pricing of Forward/Futures Contract
Cash-and-carry Arbitrage
Reverse Cash-and-carry Arbitrage
Pricing Investment Asset
Pricing Consumption Asset
Value of a forward contract
Convergence
Relationship Between forward and Futures Price
Relationship of futures price and future spot price
Expectancy Model of Futures Pricing
Types of Futures
Commodity Futures
Introduction
Benefits of Commodity Futures
Commodity Futures and Economy
Differences - Commodity and Financial Futures
Futures Contracts on Commodities
Hedging with Commodity Futures
Long and Short Positions
Short Hedge
Long Hedge
Perfect and Imperfect Hedge
Basis and Basis Risk
Hedge Ratio
Hedging for Changes in Volume
Speculation with Commodity Futures
Spread Strategies with Futures
Hedging for Gross Profit Margin
Stock and Index Futures
Introduction
Index Futures
Forward Contracts on Stocks
Futures Contracts on Indices and Individual Stocks
Features and Specifications
Margining System
Pricing Stock and Index Futures
Applications of Index Futures
Hedging Through Index Futures
Hedging Existing Portfolio
Hedge Ratio
Hedging Short Position
Insulate Against Market Risk
Controlling Risk of Stock Portfolio
Speculation with Futures
Arbitrage with Futures
Other Applications of Index Futures
Currency Forwards and Futures
Introduction
Foreign Exchange Preliminaries
Foreign Exchange Risk
Foreign Exchange Markets and Rates
Bid Rate vs. Ask Rate
Spot Rate vs. Forward Rate
Forward Premium/Discount
Currency Forwards
Foreign Exchange Transactions
Spot Transaction, Forward Transaction, Swap Transaction
Outright Forward vs Swap
Arbitrage and Foreign Exchange Rates
Hedging Through Forward Contracts
Hedging Receivables
Hedging Payables
Cost of Forward Hedge
Speculation with Forward Contracts
Arbitrage with Forward Contract
Non Deliverable Forward (NDF)
Evolution and Growth of NDF
Features of NDF
How NDF Works
NDF and Interest Rate Parity
Are NDFs Desirable
Currency Futures
Contract Specifications
Pricing Currency Futures
Hedging Through Currency Futures
Speculation with Currency Futures
Arbitrage with Currency Futures
Interest Rate and Forwards
Introduction
Interest Rate Markets
Repo and Reverse Repo Transactions
Treasury Rate
Interbank Transactions
Term Structure of Interest Rates (Yield Curve)
Treasury Zeros and YTMs
Bootstrapping Method
Continuous Compounding
Forward Rate Agreements (FRAs)
FRA - The Product, Borrower's FRA, Investor's FRA, Settlement of FRA
Pricing FRA
Hedging with FRAs
Hedging Against Rising Interest Rates
Hedging Against Falling Interest Rates
Speculation with FRAs
Arbitrage with FRAs
Interest Rate Futures
Introduction
Short term interest rate futures
Treasury Bills
Interest Rate Futures on T-bills
Futures Contracts on T-bills
Pricing of T-bills and Price Quotation on T-Bill Futures
Futures Contract on T-bills in India
Hedging with T-Bill Futures
Hedging Against Falling Yields (Long Hedge)
Hedging Against Rising Interest Rates (Short Hedge)
Speculation with T-Bill Futures
Arbitrage with T-Bill Futures
Implied Repo Rate
Pricing of T-Bill Futures
Euro Dollar Futures
Euro Dollars
Futures Contracts on Euro Dollars
Pricing of and Hedging with Euro Dollar Futures
TREASURY BOND FUTURES
Treasury Bonds
Pricing Treasury Bonds
Futures Contract on Treasury Bonds
Pricing of Treasury Bond Futures
Conversion Factor
Cheapest to Deliver Bond
Hedging Principle, Duration and Modified Duration
Optimal Hedge Ratio: Duration Based Hedging
Interest Rate Futures in India
Interest Rate and Currency Swaps
Introduction
Interest Rate Swaps
Features of Swap
Need for Swap Intermediary
Applications of Swaps
Transforming Nature of Liabilities
Transforming Nature of Assets
Hedging with Swaps
Reducing Cost of Funds
Rationale for Swaps - The Comparative Advantage
Types of Interest Rate Swaps
Fixed to Floating, Floating to Fixed, Basis Swap
Currency Swaps
Hedging Against Exchange Rate Risk with Currency Swap
Reducing Cost of Funds with Currency Swap
Distinguishing Features of Currency Swap
Valuation of Swap
Valuing Interest Rate Swap
Swap as pair of bonds
Swap as series of forward contracts
Swap Quotes and Initial Pricing
Counter party Risk and Swaps
Valuing Currency Swap
Other Swaps
Commodity Swaps
Equity Swaps
Options-Basics
Introduction
Terminology of options
Call option
Put Option
Moneyness of Options
In-the-money, At-the-money and Out-of-the-money options
Types of Options
Nature of Exercise
Nature of Markets
Nature of Underlying Asset
Understanding Options Quotations
Trading and Settlement
Assignment
Options Other than Stocks/Indices
Differences between Options and Forwards/Futures
Option Pricing - Basics
Introduction
Intrinsic Value and Time Value
BOUNDARY CONDITIONS FOR OPTION PRICING
Call Option
Put Option
ARBITRAGE BASED RELATIONSHIP OF OPTION PRICING
PUT CALL PARITY
Put Call Parity for European Options
Put Call Parity for American Options
Option Pricing - Binomial Model
Introduction
Binomial Option Pricing Model
Risk Neutral Valuation
Equivalent Portfolio Approach
Binomial Model for Put Pricing
Multi-period Binomial Model
Valuing American Options
Valuing American Call
Valuing American Put
Binomial Model for Valuing Options On Dividend Paying Stocks
Putting Binomial Model In Practice
Binomial Model for Currency Options
Binomial Model for Index Options
Monte Carlo Simulation
Options - Black scholes Model
Introduction
Factors Affecting Option Prices
Spot Price
Exercise Price
Time to Maturity
Volatility
Interest Rates
Dividend
Black Scholes Option Pricing Model
Lognormal distribution
Mean and Standard Deviations
Applying Black Scholes Model
Assumptions of Black Scholes Model
Interpreting Black Scholes Model
Put Pricing Using BSM
Merton Model for Valuing Options on Dividend Paying Stock
Valuing Options on Indices
Valuing Options on Currencies
Pseudo American Option Pricing
Black Scholes American Option Pricing for Single Dividend
Volatility - Measurement
Implied Volatility
Options Greeks-Sensitivities
Introduction
Delta and Delta Hedging
Computing Delta
Meaning of and Limits on Values of Delta
Assumption of Linearity
Behaviour of Delta
Delta and Time to Maturity
Additivity of Delta
Deltas of Other Derivatives
Delta Hedging
Delta Neutrality
Theta
Computing Theta
Meaning of Theta
Theta and Time
Theta for put option
Portfolio Theta
Gamma and Gamma Neutrality
Computing Gamma
Behaviour of Gamma with Spot Price and Time
Portfolio Gamma
Gamma Neutrality
Other Greeks
Vega
Volatility and value at Risk
Introduction
Measures of Risk
VOLATILITY
Exponential Weighted Moving Average Method
Correlation and Covariance
GARCH (1,1) Model
Volatility Index
Computing VIX
VALUE AT RISK
Introduction
Definition and Meaning of VaR
Decisions on VaR
Methods of Calculating VaR
Historical Simulation
Limitations of VaR
Stress Testing
15. Hedging with Options
Introduction
HEDGING STRATEGIES WITH OPTIONS
Hedging with Stock Options
Hedging Long Position in Stock
Hedging Short Position in Stock
Hedging Portfolios with Index Options
Hedging Long Position in Portfolio
Hedging Short Position in Portfolio
Hedging with Currency Options
Hedging Receivables
Hedging Payables
Range Forward- Zero cost structures
16. Options trading strategies
Introduction
INCOME GENERATION WITH OPTIONS
Naked Call
Writing Covered Call
Writing Put
OPTION TRADING STRATEGIES
Straddle - Long and Short
Strangle - Long and Short
Straps and Strips
Bull Spread
Bear Spread
Butterfly Spread
Condor Spread
Calendar Spreads
Diagonal Spread
Box Spread
Factor Affecting Spreads
SYNTHETIC POSITIONS
Synthetic Long Position
Synthetic Short Position
Other Synthetic Positions
17. Exotic Options
Introduction
Forward Start Option
Binary Option
Chooser Option
Shout Option
Exchange Option
Gap Option
Pay Later Option
Compound Option
Path Dependent Options
Barrier Options
Asian Options
Look-back Option
Other Exotic Options
18. Interest rate options
Introduction
Interest Rate Option
Cap
Hedging with Cap
Valuation of Cap
Floor
Valuation of Floor
Collar
Options on Bonds
Valuation of Options on Bonds
19. Options on futures and swaps
Introduction
Options on Futures
Payoff
Put Call Parity for Futures Options
Binomial Model for Futures Options
Valuation of Futures Options - Black's Model
Options on Swaps - Swaptions
Payoff
Option on Bonds and Swaptions
Valuation of Swaptions
20. Credit risk, securitization, and Credit Derivatives
Introduction
Credit Risk
Introduction
Probability of Default
Recovery Rates
Default Rates
Transition Rates
Credit Value at Risk
Credit Derivatives
Introduction
Credit Derivative
Types of Credit Risk
Credit Default Swaps
Cash flows, Settlement and Applications
Valuation of CDS - Merton Model
Total Return Swap
Features, Differences with CDS
Securitisation
Structured Credit Derivatives
Credit Linked Notes
Collateralised Debt Obligations
21. Corporate securities and derivatives
Introduction
Equity as Call option
Agency Cost of Debt
Debt as Options
Subordinated debt
Callable and Puttable Bonds
Convertible Bonds
Warrants
22. Real Options
Introduction
Kinds of Real Options
Differences in Financial and Real Options
Option to Delay
Evaluating Timing Decision with DCF
Valuing Option to Delay by Binomial Method
Discounted Cash Flow and Binomial Option Valuation
Using Black Scholes Model for Investment Timing
Option to Expand
DCF Valuation
Value Option to Expand by Binomial Method
Value Option to Expand by Black Scholes Model
Option to Abandon
DCF Valuation
Valuing Put Option using Binomial Method
Value of Put Option using Black Scholes Model
23. Weather and energy derivatives
Introduction
Weather Derivatives
Temperature
Rain
Energy Derivatives
Oil
Electricity
Natural Gas
24. Accounting for Derivatives
Introduction
Accounting Definition of Derivatives
Types of Financial Instruments
Fair Value
Fair Value Measurement
Hedge Accounting
Types of Hedges
Fair Value Hedge
Cash Flow Hedge
Steps for Hedge Accounting
Hedged Item
Hedging Instruments
Hedging Relationship
Accounting For Derivatives
Derivatives Held for Trading
Derivatives as Fair Value Hedge
Derivatives as Cash Flow Hedge
Conclusion
25. Derivatives Disasters
Introduction
The Cases
Metallgesellschaft AG
LTCM
Barings PLC
Sumitomo
Procter and Gamble
Learnings
Index

Description
This book provides a comprehensive coverage of the fundamental concepts of the subject, which will be useful to postgraduate students as well as practitioners. The book begins with an introduction to derivatives, forwards and futures, commodity futures, stock and index futures, currency forwards and futures, and then moves on to the study of interest rate and forwards, interest rate futures, and interest rate and currency swaps. This is followed by a study of topics such as options - basics, option pricing - basics, option pricing - binomial model, options - Black Scholes model, and Options Greeks - Sensitivities. Subsequently, the book covers chapters such as volatility and value at risk, hedging with options, options trading strategies, exotic options, interest rate options, options on futures and swaps. Finally, the text covers credit risk, securitization, and credit derivatives, corporate securities and derivatives, real options, weather and energy derivatives, accounting for derivatives, and derivatives disasters.