Derivatives Markets


  • Format: PDF
  • Pages: 976
  • Published Date: 2013


To be financially literate in today’s market, one must have a solid understanding of derivatives concepts and instruments and the uses of those instruments in corporations. Derivatives Markets Book has an accessible mathematical presentation, and more importantly, helps readers gain intuition by linking theories and concepts together with an engaging narrative that emphasizes the core economic principles underlying the pricing and uses of derivatives.


The book has five parts plus appendixes. Part 1 introduces the basic building blocks of derivatives: forward contracts and call and put options. Chapters 2 and 3 examine these basic instruments and some common hedging and investment strategies. Chapter 4 illustrates the use of derivatives as risk management tools and discusses why firms might care about risk management. These chapters focus on understanding the contracts and strategies, but not on pricing.

Part 2 considers the pricing of forward, futures, and swaps contracts. In these con-tracts, you are obligated to buy an asset at a pre-specified price, at a future date. What is the pre-specified price, and how is it determined? Chapter 5 examines forwards and futures on financial assets, Chapter 6 discusses commodities, and Chapter 7 looks at bond and inter-est rate forward contracts. Chapter 8 shows how swap prices can be deduced from forward prices.

Part 3 studies option pricing. Chapter 9 develops intuition about options prior to delving into the mechanics of option pricing. Chapters 10 and 11 cover binomial option pricing and Chapter 12, the Black-Scholes formula and option Greeks. Chapter 13 explains delta-hedging, which is the technique used by market-makers when managing the risk of an option position, and how hedging relates to pricing. Chapter 14 looks at a few important exotic options, including Asian options, barrier options, compound options, and exchange options.

The techniques and formulas in earlier chapters are applied in Part 4. Chapter 15 covers financial engineering, which is the creation of new financial products from the derivatives building blocks in earlier chapters. Debt and equity pricing, compensation options, and mergers are covered in Chapter 16. Chapter 17 studies real options—the application of derivatives models to the valuation and management of physical investments.

Finally, Part 5 explores pricing and hedging in depth. The material in this part explains in more detail the structure and assumptions underlying the standard derivatives models. Chapter 18 covers the lognormal model and shows how the Black-Scholes formula is a discounted expected value. Chapter 19 discusses Monte Carlo valuation, a powerful and commonly used pricing technique. Chapter 20 explains what it means to say that stock prices follow a diffusion process, and also covers Itˆo’s Lemma, which is a key result in the study of derivatives.


  • PART ONE: Insurance, Hedging, and Simple Strategies
  • PART TWO: Forwards, Futures, and Swap
  • PART THREE: Options
  • PART FOUR: Financial Engineering and Applications
  • PART FIVE: Advanced Pricing Theory and Applications