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case04 - Introduction to derivatives Fall 2011 BUSI 588...

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Introduction to derivatives, Fall 2011 BUSI 588, Case 4 Bachelier: forward contracts and foreign bonds Please prepare for class discussion on Wednesday, 9/7. Bachelier, grand-grand-grand-son of the founder of Brownie-emotion Corporation, is struggling with financial markets, in particular fixed-income instruments. He knows all about bonds, i.e. these contracts that guarantee you a given rate over a fixed amount of time. But derivatives. . . that is a different story. And, as he is learning the hard-way, derivatives seem to be an important part of his job. He has just looked at the front page of the Wall Street Journal, and learned that the current term structure of interest rates in the US is flat at 1.5%. He knows what that means: no matter what horizon he would like to invest for he can guarantee himself a 1.5% annualized-return, i.e. investing $100m over the next four months will give him 100(1 . 015) 4 / 12 by December (4 months from now).
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