1introd - Introduction Options, Futures, and Other...

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Introduction 1 Options, Futures, and Other Derivatives, 7th Edition, Copyright © John C. Hull 2008
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Derivative : a financial instrument whose value depends (or derives from) the values of other, more basic, underlying values (Hull, p. 1). 2
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To hedge risks. To speculate (take a view on the future direction of the market). To lock in an arbitrage profit. To change the nature of a liability. To change the nature of an investment without incurring the costs of selling one portfolio and buying another. 3
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Derivatives exchange : a market where individuals trade standardised contracts previously defined by the exchange. 4
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Chicago Board Options Exchange American Stock Exchange Philadelphia Stock Exchange Pacific Exchange LIFFE (London) Eurex (Europe) and many more (see list at end of book) 5
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Chicago Board of Trade Chicago Mercantile Exchange LIFFE (London) Eurex (Europe) TIFFE (Tokyo) and many more (see list at end of book) 6
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Derivatives over-the-counter markets : a telephone- and computer-linked network of dealers. Contracts are not standardised. Trades are among two financial institutions or among a financial institution and one of its customers (eg fund manager). Financial institutions usually act as market makers: prepared to quote a bid price (at which they buy) and an offer price (at which they sell). 7
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8 Source: Bank for International Settlements. Chart shows total principal amounts for OTC market and value of underlying assets for exchange market 0 50 100 150 200 250 300 350 400 450 500 550 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 OTC Exchange
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Agreement to buy or sell an asset at a certain future date ( τ ) for a future price ( K τ ). Traded in the over-the-counter market. Entering a forward contract has no cost. Long position: agrees to buy the asset. Short position: agrees to sell the asset for the same price at the same date. 9
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Spot price ( S 0 ): price of the asset in the open market at time 0 . Delivery price ( K τ ): price agreed for the transaction to be completed at time τ . 10
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Forward price ( F τ |t ): delivery price prevailing at time t for a delivery scheduled for time τ (i.e. F τ |t = K τ ) It is the delivery price that would make the contract worth exactly zero today. The forward price may be different for contracts of different maturities. 11
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This note was uploaded on 03/02/2012 for the course EC 3070 taught by Professor D.s.g.pollock during the Spring '12 term at Queen Mary, University of London.

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1introd - Introduction Options, Futures, and Other...

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