lecture note of Melbourne university
FNCE90011 Derivative Securities
Topic 1
Fundamentals
Topic Outline
Basic Concepts
Option Payoff and Profit Diagrams
Miscellaneous
Complicated Payoffs
Appendix: Market Structure
References
Hull (8th edition) Chapters 1, 4.2, 5.2, 9, 11
Hull (7th edition) Chapters 1, 4.2, 5.2, 9, 11
Hull (6th edition) Chapters 1, 4.2, 5.2, 8, 10
Copyright © John C. Handley 2012.
1. BASIC CONCEPTS
What is a derivative ?
A derivative is an asset/security whose value is completely determined by the values of one or more other ("underlying" or "state") variables.
In many cases the underlying variable is the price of a traded asset such as … stocks / shares stock index bonds / interest rates currencies commodities other derivatives
And sometimes the underlying variable appears to be a bit “crazy” … such as in the case of weather derivatives
2
The derivatives market is the market where derivative securities are traded
The four “big” classes of derivatives are:
(i) forwards and futures
(ii) options (iii) swaps (iv) credit derivatives
Users Of Derivatives hedger already has an exposure to future movements in the price of the underlying asset and is interested in reducing risk eg: you own a share and you think the stock price will fall but you do not want to sell the share … what can you do ?
3
speculator wishes to take a position in the market i.e. to take on risk with a view to making a profit. Either he is betting that the asset price will go up or that it will go down eg: you think the stock price will increase but you do not want to buy the share … what can you do ?
arbitrageur arbitrage involves locking in a riskless profit by simultaneously entering into transactions in two or more markets
This means that derivatives may be used to increase risk or to decrease risk
4
Options
A contractual agreement which gives one party the right but not the obligation to exchange a specified asset, with the other party, at a
Topic 1
Fundamentals
Topic Outline
Basic Concepts
Option Payoff and Profit Diagrams
Miscellaneous
Complicated Payoffs
Appendix: Market Structure
References
Hull (8th edition) Chapters 1, 4.2, 5.2, 9, 11
Hull (7th edition) Chapters 1, 4.2, 5.2, 9, 11
Hull (6th edition) Chapters 1, 4.2, 5.2, 8, 10
Copyright © John C. Handley 2012.
1. BASIC CONCEPTS
What is a derivative ?
A derivative is an asset/security whose value is completely determined by the values of one or more other ("underlying" or "state") variables.
In many cases the underlying variable is the price of a traded asset such as … stocks / shares stock index bonds / interest rates currencies commodities other derivatives
And sometimes the underlying variable appears to be a bit “crazy” … such as in the case of weather derivatives
2
The derivatives market is the market where derivative securities are traded
The four “big” classes of derivatives are:
(i) forwards and futures
(ii) options (iii) swaps (iv) credit derivatives
Users Of Derivatives hedger already has an exposure to future movements in the price of the underlying asset and is interested in reducing risk eg: you own a share and you think the stock price will fall but you do not want to sell the share … what can you do ?
3
speculator wishes to take a position in the market i.e. to take on risk with a view to making a profit. Either he is betting that the asset price will go up or that it will go down eg: you think the stock price will increase but you do not want to buy the share … what can you do ?
arbitrageur arbitrage involves locking in a riskless profit by simultaneously entering into transactions in two or more markets
This means that derivatives may be used to increase risk or to decrease risk
4
Options
A contractual agreement which gives one party the right but not the obligation to exchange a specified asset, with the other party, at a