168 vistas

Cargado por Karalyos-Szénási Péter

Attribution Non-Commercial (BY-NC)

- Indian Derivative Market - Final Tnr
- BAM DD 2017-01-01
- Complete English Presentation
- 1st Time Quizz
- Financial Risk
- Pgdba - Fin - Sem III - Capital Markets
- 08_chapter 1-converted.docx
- Topic 1 Intro to Derivatives & FRM.mechanics of Future Mkts
- financial derivatives
- Derivatives-Market-1.pdf
- Homework 2
- Risk Management Syllabus
- OFD Question Papers
- Derivatives BSAF2K15
- hedging 2
- Interview Questions
- Ch21-DerivaTIF
- Lecture 1 - Course Overview Ppt (1)
- jjjjjjjjjjj
- Forex Derivatives & Futures

Está en la página 1de 233

Chapter 1

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.1

A derivative is an instrument whose value depends on the values of other more basic underlying variables

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.2

Examples of Derivatives

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.3

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

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.4

Futures Contracts

A futures contract is an agreement to buy or sell an asset at a certain time in the future for a certain price By contrast in a spot contract there is an agreement to buy or sell the asset immediately (or within a very short period of time)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.5

Chicago Board of Trade Chicago Mercantile Exchange Euronext Eurex BM&F (Sao Paulo, Brazil) and many more (see list at end of book)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.6

Futures Price

The futures prices for a particular contract is the price at which you agree to buy or sell It is determined by supply and demand in the same way as a spot price

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.7

Electronic Trading

Traditionally futures contracts have been traded using the open outcry system where traders physically meet on the floor of the exchange Increasingly this is being replaced by electronic trading where a computer matches buyers and sellers

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.8

Agreement to: buy 100 oz. of gold @ US$600/oz. in December (NYMEX) sell 62,500 @ 1.9800 US$/ in March (CME) sell 1,000 bbl. of oil @ US$65/bbl. in April (NYMEX)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.9

Terminology

The party that has agreed to buy has a long position The party that has agreed to sell has a short position

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.10

Example

January: an investor enters into a long futures contract on COMEX to buy 100 oz of gold @ $600 in April April: the price of gold $615 per oz What is the investors profit?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.11

The over-the counter market is an important alternative to exchanges It is a telephone and computer-linked network of dealers who do not physically meet Trades are usually between financial institutions, corporate treasurers, and fund managers

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.12

(Figure 1.2, Page 4)

Source: Bank for International Settlements. Chart shows total principal amounts for OTC market and value of underlying assets for exchange market

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.13

Forward Contracts

Forward contracts are similar to futures except that they trade in the over-thecounter market Forward contracts are popular on currencies and interest rates

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.14

Foreign Exchange Quotes for GBP on July 14, 2006 (See page 5)

Bid 1.8360 1.8372 1.8400 1.8438 Offer 1.8364 1.8377 1.8405 1.8444

1.15

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Options

A call option is an option to buy a certain asset by a certain date for a certain price (the strike price) A put option is an option to sell a certain asset by a certain date for a certain price (the strike price)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.16

An American option can be exercised at any time during its life A European option can be exercised only at maturity

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.17

Intel Option Prices (Sept 12, 2006; Stock Price=19.56); See page 6

Calls Jan 2007 4.950 2.775 1.175 0.375 0.125 Puts Jan 2007 0.150 0.475 1.375 3.100 5.450

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.18

Chicago Board Options Exchange American Stock Exchange Philadelphia Stock Exchange International Securities Exchange Eurex (Europe) and many more (see list at end of book)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.19

Options vs Futures/Forwards

A futures/forward contract gives the holder the obligation to buy or sell at a certain price An option gives the holder the right to buy or sell at a certain price

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.20

Hedge funds trade derivatives for all three reasons (See Business Snapshot 1.1) When a trader has a mandate to use derivatives for hedging or arbitrage, but then switches to speculation, large losses can result. (See Barings, Business Snapshot 1.2)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.21

page 11)

A US company will pay 10 million for imports from Britain in 3 months and decides to hedge using a long position in a forward contract An investor owns 1,000 Microsoft shares currently worth $28 per share. A two-month put with a strike price of $27.50 costs $1. The investor decides to hedge by buying 10 contracts

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.22

Value of Microsoft Shares with and without Hedging (Fig 1.4, page 12)

40,000 Value of Holding ($)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.23

An investor with $2,000 to invest feels that Amazon.coms stock price will increase over the next 2 months. The current stock price is $20 and the price of a 2-month call option with a strike of $22.50 is $1 What are the alternative strategies?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.24

A stock price is quoted as 100 in London and $182 in New York The current exchange rate is 1.8500 What is the arbitrage opportunity?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.25

Suppose that: The spot price of gold is US$600 The quoted 1-year futures price of gold is US$650 The 1-year US$ interest rate is 5% per annum No income or storage costs for gold Is there an arbitrage opportunity?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.26

Suppose that: The spot price of gold is US$600 The quoted 1-year futures price of gold is US$590 The 1-year US$ interest rate is 5% per annum No income or storage costs for gold Is there an arbitrage opportunity?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.27

If the spot price of gold is S & the futures price is for a contract deliverable in T years is F, then F = S (1+r )T where r is the 1-year (domestic currency) riskfree rate of interest. In our examples, S=600, T=1, and r=0.05 so that F = 600(1+0.05) = 630

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.28

Suppose that: The spot price of oil is US$70 The quoted 1-year futures price of oil is US$80 The 1-year US$ interest rate is 5% per annum The storage costs of oil are 2% per annum Is there an arbitrage opportunity?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.29

Suppose that: The spot price of oil is US$70 The quoted 1-year futures price of oil is US$65 The 1-year US$ interest rate is 5% per annum The storage costs of oil are 2% per annum Is there an arbitrage opportunity?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

1.30

Chapter 2

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.1

Futures Contracts

Available on a wide range of underlyings Exchange traded Specifications need to be defined:

What can be delivered, Where it can be delivered, & When it can be delivered

Settled daily

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.2

Margins

A margin is cash or marketable securities deposited by an investor with his or her broker The balance in the margin account is adjusted to reflect daily settlement Margins minimize the possibility of a loss through a default on a contract

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.3

An investor takes a long position in 2 December gold futures contracts on June 5

contract size is 100 oz. futures price is US$400 margin requirement is US$2,000/contract (US$4,000 in total) maintenance margin is US$1,500/contract (US$3,000 in total)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.4

A Possible Outcome

Table 2.1, Page 27

Daily Gain (Loss) (US$) Cumulative Gain (Loss) (US$) Margin Account Margin Balance Call (US$) (US$) 4,000 (600) . . . (420) . . . (1,140) . . . 260 (600) . . . (1,340) . . . (2,600) . . . (1,540) 3,400 . . . 0 . . . Futures Price (US$) 400.00 5-Jun 397.00 . . . . . . 13-Jun 393.30 . . . . . . 19-Jun 387.00 . . . . . . 26-Jun 392.30

Day

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.5

They are settled daily Closing out a futures position involves entering into an offsetting trade Most contracts are closed out before maturity

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.6

It is becoming increasingly common for contracts to be collateralized in OTC markets They are then similar to futures contracts in that they are settled regularly (e.g. every day or every week)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.7

Delivery

If a futures contract is not closed out before maturity, it is usually settled by delivering the assets underlying the contract. When there are alternatives about what is delivered, where it is delivered, and when it is delivered, the party with the short position chooses. A few contracts (for example, those on stock indices and Eurodollars) are settled in cash

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.8

Some Terminology

Open interest: the total number of contracts outstanding equal to number of long positions or number of short positions Settlement price: the price just before the final bell each day used for the daily settlement process Volume of trading: the number of trades in 1 day

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.9

(Figure 2.1, page 25)

Time

Time

(a)

(b)

2.10

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Questions

When a new trade is completed what are the possible effects on the open interest? Can the volume of trading in a day be greater than the open interest?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.11

Regulation of Futures

Regulation is designed to protect the public interest Regulators try to prevent questionable trading practices by either individuals on the floor of the exchange or outside groups

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.12

It is logical to recognize hedging profits (losses) at the same time as the losses (profits) on the item being hedged It is logical to recognize profits and losses from speculation on a mark to market basis Roughly speaking, this is what the accounting and tax treatment of futures in the U.S.and many other countries attempts to achieve

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.13

Forward Contracts

A forward contract is an OTC agreement to buy or sell an asset at a certain time in the future for a certain price There is no daily settlement (unless a collateralization agreement requires it). At the end of the life of the contract one party buys the asset for the agreed price from the other party

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.14

Profit

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.15

Profit

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.16

Forward Private contract between two parties Not standardized Usually one specified delivery date Settled at end of contract Delivery or final settlement usual Some credit risk Futures Traded on an exchange Standardized Range of delivery dates Settled daily Usually closed out prior to maturity Virtually no credit risk

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.17

Futures exchange rates are quoted as the number of USD per unit of the foreign currency Forward exchange rates are quoted in the same way as spot exchange rates. This means that GBP, EUR, AUD, and NZD are USD per unit of foreign currency. Other currencies (e.g., CAD and JPY) are quoted as units of the foreign currency per USD.

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

2.18

Chapter 3

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.1

A long futures hedge is appropriate when you know you will purchase an asset in the future and want to lock in the price A short futures hedge is appropriate when you know you will sell an asset in the future & want to lock in the price

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.2

Companies should focus on the main business they are in and take steps to minimize risks arising from interest rates, exchange rates, and other market variables

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.3

Shareholders are usually well diversified and can make their own hedging decisions It may increase risk to hedge when competitors do not Explaining a situation where there is a loss on the hedge and a gain on the underlying can be difficult

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.4

(Hedge initiated at time t1 and closed out at time t2)

Futures Price

Spot Price

Time t1 t2 3.5

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Basis Risk

Basis is the difference between spot & futures Basis risk arises because of the uncertainty about the basis when the hedge is closed out

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.6

Long Hedge

Suppose that F1 : Initial Futures Price F2 : Final Futures Price S2 : Final Asset Price You hedge the future purchase of an asset by entering into a long futures contract Cost of Asset=S2 (F2 F1) = F1 + Basis

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.7

Short Hedge

Suppose that F1 : Initial Futures Price F2 : Final Futures Price S2 : Final Asset Price You hedge the future sale of an asset by entering into a short futures contract Price Realized=S2+ (F1 F2) = F1 + Basis

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.8

Choice of Contract

Choose a delivery month that is as close as possible to, but later than, the end of the life of the hedge When there is no futures contract on the asset being hedged, choose the contract whose futures price is most highly correlated with the asset price. There are then 2 components to basis

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.9

Proportion of the exposure that should optimally be hedged is S h= F where S is the standard deviation of S, the change in the spot price during the hedging period, F is the standard deviation of F, the change in the futures price during the hedging period is the coefficient of correlation between S and F.

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.10

(Page 62)

To hedge the risk in a portfolio the number of contracts that should be shorted is P

F

where P is the value of the portfolio, is its beta, and F is the current value of one futures (=futures price times contract size)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.11

Desire to be out of the market for a short period of time. (Hedging may be cheaper than selling the portfolio and buying it back.) Desire to hedge systematic risk (Appropriate when you feel that you have picked stocks that will outpeform the market.)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.12

Example

Futures price of S&P 500 is 1,000 Size of portfolio is $5 million Beta of portfolio is 1.5 One contract is on $250 times the index What position in futures contracts on the S&P 500 is necessary to hedge the portfolio?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.13

Changing Beta

What position is necessary to reduce the beta of the portfolio to 0.75? What position is necessary to increase the beta of the portfolio to 2.0?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.14

We can use a series of futures contracts to increase the life of a hedge Each time we switch from 1 futures contract to another we incur a type of basis risk

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

3.15

Interest Rates

Chapter 4

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.1

Types of Rates

Treasury rates LIBOR rates Repo rates

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.2

The compounding frequency used for an interest rate is the unit of measurement The difference between quarterly and annual compounding is analogous to the difference between miles and kilometers

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.3

Continuous Compounding

(Page 77)

In the limit as we compound more and more frequently we obtain continuously compounded interest rates $100 grows to $100eRT when invested at a continuously compounded rate R for time T $100 received at time T discounts to $100e-RT at time zero when the continuously compounded discount rate is R

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.4

Conversion Formulas

(Page 77)

Define Rc : continuously compounded rate Rm: same rate with compounding m times per year

Rm R c = m ln 1 + m R m = m e Rc / m 1

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.5

Zero Rates

A zero rate (or spot rate), for maturity T is the rate of interest earned on an investment that provides a payoff only at time T

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.6

Maturity Zero Rate (years) (% cont. comp.) 0.5 1.0 1.5 2.0 5.0 5.8 6.4 6.8

4.7

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Bond Pricing

To calculate the cash price of a bond we discount each cash flow at the appropriate zero rate In our example, the theoretical price of a twoyear bond providing a 6% coupon semiannually is

3e

0.05 0.5

+ 3e

0.058 1.0

+ 3e

0.064 1.5

+ 103e

0.068 2 .0

= 98.39

4.8

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Bond Yield

The bond yield is the discount rate that makes the present value of the cash flows on the bond equal to the market price of the bond Suppose that the market price of the bond in our example equals its theoretical price of 98.39 The bond yield is given by solving 3e y 0.5 + 3e y 1.0 + 3e y 1.5 + 103e y 2 .0 = 98.39 to get y = 0.0676 or 6.76%.

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.9

Par Yield

The par yield for a certain maturity is the coupon rate that causes the bond price to equal its face value. In our example we solve

c 0.050.5 c 0.0581.0 c 0.0641.5 + e + e e 2 2 2 c 0.0682.0 + 100 + e = 100 2 to get c=6.87 (with s.a. compounding)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.10

In general if m is the number of coupon payments per year, P is the present value of $1 received at maturity and A is the present value of an annuity of $1 on each coupon date

(100 100 P ) m c= A

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.11

Bond Principal (dollars) 100 100 100 100 100 Time to Maturity (years) 0.25 0.50 1.00 1.50 2.00 Annual Coupon (dollars) 0 0 0 8 12 Bond Price (dollars) 97.5 94.9 90.0 96.0 101.6

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.12

An amount 2.5 can be earned on 97.5 during 3 months. The 3-month rate is 4 times 2.5/97.5 or 10.256% with quarterly compounding This is 10.127% with continuous compounding Similarly the 6 month and 1 year rates are 10.469% and 10.536% with continuous compounding

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.13

To calculate the 1.5 year rate we solve

4e

0.10469 0.5

+ 4e

0.10536 1.0

+ 104 e

R 1.5

= 96

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.14

Zero Curve Calculated from the Data (Figure 4.1, page 82)

12

11

10.681 10.469

10

10.808

10.536

10.127

Maturity (yrs)

9 0 0.5 1 1.5 2 2.5

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.15

Forward Rates

The forward rate is the future zero rate implied by todays term structure of interest rates

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.16

Table 4.5, page 82

Zero Rate for Year (n ) 1 2 3 4 5 (% per annum) 3.0 4.0 4.6 5.0 5.3 5.0 5.8 6.2 6.5

4.17

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Suppose that the zero rates for time periods T1 and T2 are R1 and R2 with both rates continuously compounded. The forward rate for the period between times T1 and T2 is

R2 T2 R1 T1 T2 T1

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.18

For an upward sloping yield curve: Fwd Rate > Zero Rate > Par Yield For a downward sloping yield curve Par Yield > Zero Rate > Fwd Rate

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.19

A forward rate agreement (FRA) is an agreement that a certain rate will apply to a certain principal during a certain future time period

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.20

An FRA is equivalent to an agreement where interest at a predetermined rate, RK is exchanged for interest at the market rate An FRA can be valued by assuming that the forward interest rate is certain to be realized

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.21

FRA Example

A company has agreed that it will receive 4% on $100 million for 3 months starting in 3 years The forward rate for the period between 3 and 3.25 years is 3% The value of the contract to the company is +$250,000 discounted from time 3.25 years to time zero

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.22

Suppose rate proves to be 4.5% (with quarterly compounding The payoff is $125,000 at the 3.25 year point This is equivalent to a payoff of $123,609 at the 3-year point.

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.23

Page 87

Expectations Theory: forward rates equal expected future zero rates Market Segmentation: short, medium and long rates determined independently of each other Liquidity Preference Theory: forward rates higher than expected future zero rates

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.24

Suppose that the markets best guess is that future short term rates will equal todays rates What would happen if a bank posted the following rates?

Maturity (yrs) 1 5 Deposit Rate 3% 3% Mortgage Rate 6% 6%

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

4.25

Chapter 5

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.1

Investment assets are assets held by significant numbers of people purely for investment purposes (Examples: gold, silver) Consumption assets are assets held primarily for consumption (Examples: copper, oil)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.2

Short selling involves selling securities you do not own Your broker borrows the securities from another client and sells them in the market in the usual way

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.3

Short Selling

(continued)

At some stage you must buy the securities back so they can be replaced in the account of the client You must pay dividends and other benefits the owner of the securities receives

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.4

Notation

S0: Spot price today F0: Futures or forward price today T: Time until delivery date r: Risk-free interest rate for maturity T

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.5

Suppose that: The spot price of gold is US$600 The quoted 1-year futures price of gold is US$650 The 1-year US$ interest rate is 5% per annum No income or storage costs for gold Is there an arbitrage opportunity?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.6

Suppose that: The spot price of gold is US$600 The quoted 1-year futures price of gold is US$590 The 1-year US$ interest rate is 5% per annum No income or storage costs for gold Is there an arbitrage opportunity?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.7

If the spot price of gold is S & the futures price is for a contract deliverable in T years is F, then F = S (1+r )T where r is the 1-year (domestic currency) riskfree rate of interest. In our examples, S=600, T=1, and r=0.05 so that F = 600(1+0.05) = 630

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.8

F0 = S0erT

This equation relates the forward price and the spot price for any investment asset that provides no income and has no storage costs

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.9

(page 104, equation 5.2)

F0 = (S0 I )erT where I is the present value of the income during life of forward contract

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.10

(Page 105, equation 5.3)

F0 = S0 e(rq )T

where q is the average yield during the life of the contract (expressed with continuous compounding)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.11

Page 106

Suppose that K is delivery price in a forward contract & F0 is forward price that would apply to the contract today The value of a long forward contract, , is = (F0 K )erT Similarly, the value of a short forward contract is (K F0 )erT

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.12

Forward and futures prices are usually assumed to be the same. When interest rates are uncertain they are, in theory, slightly different: A strong positive correlation between interest rates and the asset price implies the futures price is slightly higher than the forward price A strong negative correlation implies the reverse

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.13

Can be viewed as an investment asset paying a dividend yield The futures price and spot price relationship is therefore

F0 = S0 e(rq )T

where q is the dividend yield on the portfolio represented by the index during life of contract

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.14

Stock Index

(continued)

For the formula to be true it is important that the index represent an investment asset In other words, changes in the index must correspond to changes in the value of a tradable portfolio The Nikkei index viewed as a dollar number does not represent an investment asset

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.15

Index Arbitrage

When F0 > S0e(r-q)T an arbitrageur buys the stocks underlying the index and sells futures When F0 < S0e(r-q)T an arbitrageur buys futures and shorts or sells the stocks underlying the index

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.16

Index Arbitrage

(continued)

Index arbitrage involves simultaneous trades in futures and many different stocks Very often a computer is used to generate the trades Occasionally (e.g., on Black Monday) simultaneous trades are not possible and the theoretical no-arbitrage relationship between F0 and S0 does not hold

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.17

A foreign currency is analogous to a security providing a dividend yield The continuous dividend yield is the foreign risk-free interest rate It follows that if rf is the foreign risk-free interest rate

F0 = S 0 e

( r rf ) T

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.18

Figure 5.1, page 111

1000 units of foreign currency at time zero

1000 e

rf T

1000 F0 e

rf T

dollars at time T

1000S 0e rT

dollars at time T

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.19

(Page 115)

F0 S0 e(r+u )T

where u is the storage cost per unit time as a percent of the asset value. Alternatively,

F0 (S0+U )erT

where U is the present value of the storage costs.

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.20

The cost of carry, c, is the storage cost plus the interest costs less the income earned For an investment asset F0 = S0ecT For a consumption asset F0 S0ecT The convenience yield on the consumption asset, y, is defined so that F0 = S0 e(cy )T

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.21

Suppose k is the expected return required by investors on an asset We can invest F0er T now to get ST back at maturity of the futures contract This shows that

F0 = E (ST )e(rk )T

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.22

If the asset has no systematic risk, then k = r and F0 is an unbiased estimate of ST positive systematic risk, then k > r and F0 < E (ST ) negative systematic risk, then k < r and F0 > E (ST )

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

5.23

Chapter 6

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.1

Treasury Bonds: Actual/Actual (in period) Corporate Bonds: 30/360 Money Market Instruments: Actual/360

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.2

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.3

If Y is the cash price of a Treasury bill that has n days to maturity the quoted price is

360 (100 Y ) n

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.4

Pages 130-134

Cash price received by party with short position = Most Recent Settlement Price Conversion factor + Accrued interest

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.5

Conversion Factor

The conversion factor for a bond is approximately equal to the value of the bond on the assumption that the yield curve is flat at 6% with semiannual compounding

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.6

Factors that affect the futures price: Delivery can be made any time during the delivery month Any of a range of eligible bonds can be delivered The wild card play

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.7

If Q is the quoted price of a Eurodollar futures contract, the value of one contract is 10,000[100-0.25(100-Q)] A change of one basis point or 0.01 in a Eurodollar futures quote corresponds to a contract price change of $25

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.8

A Eurodollar futures contract is settled in cash When it expires (on the third Wednesday of the delivery month) Q is set equal to 100 minus the 90 day Eurodollar interest rate (actual/360) and all contracts are closed out

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.9

page 136)

It is Jan 8. An investor wants to lock in the interest rate for 3 months starting June 20 on $5 million The investor buys 5 June Eurodollar futures contracts at 94.79. On June 20 the final settlement price is 96 What interest rate has the investor locked in?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.10

Eurodollar futures are setrlled daily; FRAs are not The payoff from Eurodollar futures is at the beginning of the period covered by the underlying interest rate; the payoff from FRAs is at the end of this period

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.11

Eurodollar futures contracts last as long as 10 years For Eurodollar futures lasting beyond two years we cannot assume that the forward rate equals the futures rate

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.12

A " convexity adjustment " often made is 1 2 Forward rate = Futures rate t1t 2 2 where t1 is the time to maturity of the futures contract, t 2 is the maturity of the rate underlying the futures contract (90 days later than t1 ) and is the standard deviation of the short rate changes per year (typically is about 0.012)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.13

Duration of a bond that provides cash flow ci at time ti is

i =1

c i e yt i ti B

where B is its price and y is its yield (continuously compounded) This leads to

B = Dy B

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.14

Duration Continued

When the yield y is expressed with compounding m times per year

BDy B = 1+ y m

The expression

D 1+ y m

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.15

Duration Matching

This involves hedging against interest rate risk by matching the durations of assets and liabilities It provides protection against small parallel shifts in the zero curve

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.16

PDP FC DF

FC DF P DP

Contract Price for Interest Rate Futures Duration of Asset Underlying Futures at Maturity Value of portfolio being Hedged Duration of Portfolio at Hedge Maturity

6.17

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Three month hedge is required for a $10 million portfolio. Duration of the portfolio in 3 months will be 6.8 years. 3-month T-bond futures price is 93-02 so that contract price is $93,062.50 Duration of cheapest to deliver bond in 3 months is 9.2 years Number of contracts for a 3-month hedge is

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

6.18

Swaps

Chapter 7

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.1

Nature of Swaps

A swap is an agreement to exchange cash flows at specified future times according to certain specified rules

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.2

An agreement by Microsoft to receive 6-month LIBOR & pay a fixed rate of 5% per annum every 6 months for 3 years on a notional principal of $100 million Next slide illustrates cash flows

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.3

(See Table 7.1, page 155)

---------Millions of Dollars--------LIBOR FLOATING FIXED Date Mar.5, 2007 Sept. 5, 2007 Mar.5, 2008 Sept. 5, 2008 Mar.5, 2009 Sept. 5, 2009 Mar.5, 2010 Rate 4.2% 4.8% 5.3% 5.5% 5.6% 5.9% 6.4% +2.10 +2.40 +2.65 +2.75 +2.80 +2.95 2.50 2.50 2.50 2.50 2.50 2.50 0.40 0.10 +0.15 +0.25 +0.30 +0.45

7.4

Net

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Converting a liability from fixed rate to floating rate floating rate to fixed rate Converting an investment from fixed rate to floating rate floating rate to fixed rate

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.5

(Figure 7.2, page 156)

5% 5.2%

Intel

LIBOR

MS

LIBOR+0.1%

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.6

(Figure 7.4, page 158)

4.985% 5.2%

5.015%

Intel

LIBOR

F.I.

LIBOR

MS

LIBOR+0.1%

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.7

(Figure 7.3, page 157)

5% 4.7%

Intel

LIBOR-0.2% LIBOR

MS

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.8

(See Figure 7.5, page 159)

4.985%

5.015% 4.7%

Intel

LIBOR-0.2% LIBOR

F.I.

LIBOR

MS

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.9

(Table 7.3, page 159) Maturity 2 years 3 years 4 years 5 years 7 years 10 years Bid (%) 6.03 6.21 6.35 6.47 6.65 6.83 Offer (%) 6.06 6.24 6.39 6.51 6.68 6.87 Swap Rate (%) 6.045 6.225 6.370 6.490 6.665 6.850

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.10

AAACorp wants to borrow floating BBBCorp wants to borrow fixed

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.11

3.95% 4%

AAA

LIBOR

BBB

LIBOR+1%

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.12

(Figure 7.7, page 163)

3.93% 4%

3.97%

AAA

LIBOR

F.I.

LIBOR

BBB

LIBOR+1%

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.13

The 4.0% and 5.2% rates available to AAACorp and BBBCorp in fixed rate markets are 5-year rates The LIBOR+0.3% and LIBOR+1% rates available in the floating rate market are sixmonth rates BBBCorps fixed rate depends on the spread above LIBOR it borrows at in the future

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.14

Six-month LIBOR is a short-term AA borrowing rate The 5-year swap rate has a risk corresponding to the situation where 10 sixmonth loans are made to AA borrowers at LIBOR This is because the lender can enter into a swap where income from the LIBOR loans is exchanged for the 5-year swap rate

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.15

Interest rate swaps can be valued as the difference between the value of a fixed-rate bond and the value of a floating-rate bond Alternatively, they can be valued as a portfolio of forward rate agreements (FRAs)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.16

The fixed rate bond is valued in the usual way The floating rate bond is valued by noting that it is worth par immediately after the next payment date

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.17

Receive 8% per annum and pay floating semiannually on a principal of $100 million. 1.25 years to go and next floating payment is $5.1 million

Time 0.25 0.75 1.25 Fixed Bond 4 4 104 Floating Bond 105.1 Disc Factor 0.9753 0.9243 0.8715 PV fixed PV floating Bond Bond 3.901 102.5045 3.697 90.64 98.238 102.505

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.18

Each exchange of payments in an interest rate swap is an FRA The FRAs can be valued on the assumption that todays forward rates are realized

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.19

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.20

An agreement to pay 5% on a sterling principal of 10,000,000 & receive 6% on a US$ principal of $15,000,000 every year for 5 years

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.21

Exchange of Principal

In an interest rate swap the principal is not exchanged In a currency swap the principal is exchanged at the beginning and the end of the swap

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.22

Dollars Pounds $ ------millions-----18.00 +10.00 +1.08 0.5 +1.08 0.5 +1.08 0.5 +1.08 0.5 +19.08 10.5

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.23

Conversion from a liability in one currency to a liability in another currency Conversion from an investment in one currency to an investment in another currency

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.24

Comparative Advantage Arguments for Currency Swaps (Table 7.6, page 172)

General Electric wants to borrow AUD Qantas wants to borrow USD

USD General Motors Qantas 5.0% 7.0% AUD 7.6% 8.0%

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.25

Like interest rate swaps, currency swaps can be valued either as the difference between 2 bonds or as a portfolio of forward contracts (See Examples 7.6 and 7.7)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.26

A swap can be regarded as a convenient way of packaging forward contracts When a swap is initiated the swap has zero value, but typically some forwards have a positive value and some have a negative value

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.27

Credit Risk

A swap is worth zero to a company initially At a future time its value is liable to be either positive or negative The company has credit risk exposure only when its value is positive

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.28

Amortizing/ step up Compounding swap Constant maturity swap LIBOR-in-arrears swap Accrual swap Equity swap

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.29

Cross currency interest rate swap Floating-for-floating currency swap Diff swap Commodity swap Variance swap

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

7.30

Chapter 8

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.1

Types of Options

A call is an option to buy A put is an option to sell A European option can be exercised only at the end of its life An American option can be exercised at any time

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.2

Option Positions

Long call Long put Short call Short put

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.3

Long Call

(Figure 8.1, Page 186)

Profit from buying one European call option: option price = $5, strike price = $100. 30 Profit ($) 20 10 70 0 -5 80 90 100 Terminal stock price ($) 110 120 130

8.4

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Short Call

(Figure 8.3, page 188)

Profit from writing one European call option: option price = $5, strike price = $100 Profit ($) 5 0 -10 -20 -30

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.5

Long Put

(Figure 8.2, page 188)

Profit from buying a European put option: option price = $7, strike price = $70 30 Profit ($) 20 10 0 -7 40 50 60 70 80 Terminal stock price ($) 90 100

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.6

Short Put

(Figure 8.4, page 189)

Profit from writing a European put option: option price = $7, strike price = $70 Profit ($) 7 0 -10 -20 -30

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

40

50

60 70 80

8.7

What is the Option Position in Each Case?

8.8

ST

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Page 190-191

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.9

Expiration date Strike price European or American Call or Put (option class)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.10

Terminology

Moneyness : At-the-money option In-the-money option Out-of-the-money option

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.11

Terminology

(continued)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.12

(Page 193-194)

Suppose you own N options with a strike price of K : No adjustments are made to the option terms for cash dividends When there is an n-for-m stock split, the strike price is reduced to mK/n the no. of options is increased to nN/m Stock dividends are handled in a manner similar to stock splits

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.13

(continued)

Consider a call option to buy 100 shares for $20/share How should terms be adjusted: for a 2-for-1 stock split? for a 5% stock dividend?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.14

Market Makers

Most exchanges use market makers to facilitate options trading A market maker quotes both bid and ask prices when requested The market maker does not know whether the individual requesting the quotes wants to buy or sell

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.15

Margins are required when options are sold For example when a naked call option is written the margin is the greater of: 1 A total of 100% of the proceeds of the sale plus 20% of the underlying share price less the amount (if any) by which the option is out of the money 2 A total of 100% of the proceeds of the sale plus 10% of the underlying share price

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.16

Warrants

Warrants are options that are issued (or written) by a corporation or a financial institution The number of warrants outstanding is determined by the size of the original issue & changes only when they are exercised or when they expire

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.17

Warrants

(continued)

Warrants are traded in the same way as stocks The issuer settles up with the holder when a warrant is exercised When call warrants are issued by a corporation on its own stock, exercise will lead to new treasury stock being issued

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.18

Option issued by a company to executives When the option is exercised the company issues more stock Usually at-the-money when issued

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.19

They become vested after a period of time (usually 1 to 4 years) They cannot be sold They often last for as long as 10 or 15 years Accounting standards are changing to require the expensing of executive stock options

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.20

Convertible Bonds

Convertible bonds are regular bonds that can be exchanged for equity at certain times in the future according to a predetermined exchange ratio

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.21

Convertible Bonds

(continued)

Very often a convertible is callable The call provision is a way in which the issuer can force conversion at a time earlier than the holder might otherwise choose

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

8.22

Chapter 9

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.1

Notation

c : European call option price p : European put option price S0 : Stock price today K : Strike price T : Life of option : Volatility of stock price C : American Call option price P : American Put option price ST :Stock price at option maturity D : Present value of dividends during options life r : Risk-free rate for maturity T with cont. comp.

9.2

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Variable S0 K T r D c p C P

+ ? + +

+ ? + +

+ + + +

+ + + +

9.3

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

An American option is worth at least as much as the corresponding European option Cc Pp

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.4

Suppose that c=3 T=1 K = 18

S0 = 20 r = 10% D=0

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.5

9.1, page 215)

c S0 Ke

-rT

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.6

Suppose that p =1 T = 0.5 K = 40 Is there an arbitrage opportunity?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

S0 = 37 r =5% D =0

9.7

(Equation 9.2, page 217)

p Ke

-rTS

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.8

(Equation 9.3, page 217)

Consider the following 2 portfolios: Portfolio A: European call on a stock + PV of the strike price in cash Portfolio C: European put on the stock + the stock Both are worth max(ST , K ) at the maturity of the options They must therefore be worth the same today. This means that

c + Ke -rT = p + S0

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.9

Arbitrage Opportunities

Suppose that c =3 S0 = 31 T = 0.25 r = 10% K =30 D=0 What are the arbitrage possibilities when p = 2.25 ? p=1?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.10

Early Exercise

Usually there is some chance that an American option will be exercised early An exception is an American call on a non-dividend paying stock This should never be exercised early

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.11

An Extreme Situation

For an American call option: S0 = 100; T = 0.25; K = 60; D = 0 Should you exercise immediately? What should you do if

You want to hold the stock for the next 3 months? You do not feel that the stock is worth holding for the next 3 months?

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.12

No income is sacrificed We delay paying the strike price Holding the call provides insurance against stock price falling below strike price

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.13

Are there any advantages to exercising an American put when S0 = 60; T = 0.25; r=10% K = 100; D = 0

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.14

(Equations 9.5 and 9.6, pages 223-224)

c S0 D Ke

p D + Ke

rT

rT

S0

9.15

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

American options; D = 0 S0 - K < C - P < S0 - Ke -rT

Equation 9.4 p. 220

Equation 9.7 p. 224

Equation 9.8 p. 224

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

9.16

Chapter 10

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.1

Take a position in the option and the underlying Take a position in 2 or more options of the same type (A spread) Combination: Take a position in a mixture of calls & puts (A combination)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.2

Profit Profit

K K

(a) Profit Profit

ST

(b)

ST

K ST

(c)

K

(d)

ST

10.3

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

(Figure 10.2, page 231)

Profit ST K1 K2

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.4

Figure 10.3, page 233

Profit K1 K2 ST

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.5

Figure 10.4, page 233

Profit

K1

K2

ST

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.6

Figure 10.5, page 234

Profit

K1

K2

ST

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.7

Box Spread

A combination of a bull call spread and a bear put spread If all options are European a box spread is worth the present value of the difference between the strike prices If they are American this is not necessarily so (see Business Snapshot 10.1)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.8

Figure 10.6, page 237

Profit K1 K2 K3 ST

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.9

Figure 10.7, page 238

Profit K1 K2 K3 ST

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.10

Figure 10.8, page 238

Profit ST K

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.11

Figure 10.9, page 239

Profit ST K

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.12

A Straddle Combination

Figure 10.10, page 240

Profit

ST

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.13

Figure 10.11, page 241

Profit

Profit

K Strip

ST

K Strap

ST

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.14

A Strangle Combination

Figure 10.12, page 242

Profit K1 K2 ST

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

10.15

Chapter 11

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.1

A stock price is currently $20 In three months it will be either $22 or $18

Stock Price = $22 Stock price = $20 Stock Price = $18

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.2

A 3-month call option on the stock has a strike price of 21. Stock Price = $22 Option Price = $1 Stock price = $20 Option Price=? Stock Price = $18 Option Price = $0

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.3

Consider the Portfolio: long shares short 1 call option 22 1

18

= 0.25

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.4

(Risk-Free Rate is 12%)

The riskless portfolio is: long 0.25 shares short 1 call option The value of the portfolio in 3 months is 22 0.25 1 = 4.50 The value of the portfolio today is 4.5e 0.120.25 = 4.3670

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.5

The portfolio that is long 0.25 shares short 1 option is worth 4.367 The value of the shares is 5.000 (= 0.25 20 ) The value of the option is therefore 0.633 (= 5.000 4.367 )

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.6

A derivative lasts for time T and is dependent on a stock

Su u Sd d

11.7

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Generalization

(continued)

Consider the portfolio that is long shares and short 1 derivative Su u Sd d The portfolio is riskless when Su u = Sd d or

u f d = Su Sd

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.8

Generalization

(continued)

Value of the portfolio at time T is Su u Value of the portfolio today is (Su u )erT Another expression for the portfolio value today is S f Hence = S (Su u )erT

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.9

Generalization

(continued)

= [ p u + (1 p )d ]erT

where

p =

d u d

rT

11.10

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

Risk-Neutral Valuation

= [ p u + (1 p )d ]e-rT The variables p and (1 p ) can be interpreted as the risk-neutral probabilities of up and down movements The value of a derivative is its expected payoff in a risk-neutral world discounted at the risk-free rate

Su u Sd d

11.11

(1

p)

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

When we are valuing an option in terms of the underlying stock the expected return on the stock is irrelevant

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.12

p

Su = 22 u = 1 Sd = 18 d = 0

S

(1 p)

Since p is a risk-neutral probability 20e0.12 0.25 = 22p + 18(1 p ); p = 0.6523 Alternatively, we can use the formula

e rT d e 0.12 0.25 0 .9 = 0 . 6523 p= = ud 1 .1 0 .9

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.13

Su = 22 u = 1 Sd = 18 d = 0

52 3 0.6

0.34 77

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.14

A Two-Step Example

Figure 11.3, page 253

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

19.8

11.15

Figure 11.4, page 253

D

22 20 1.2823

A

B E C F

2.0257 18 0.0

Value at node B = e0.120.25(0.65233.2 + 0.34770) = 2.0257 Value at node A = e0.120.25(0.65232.0257 + 0.34770) = 1.2823

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.16

Figure 11.7, page 256

K = 52, t = 1yr r = 5%

60 50 4.1923

A B E

72 0 48 4 32 20

1.4147 40

C

9.4636

F

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.17

D

60 50 5.0894

A

72 0 48 4 32 20

B E

1.4147 40

C

12.0

F

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.18

Delta

Delta () is the ratio of the change in the price of a stock option to the change in the price of the underlying stock The value of varies from node to node

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.19

Choosing u and d

One way of matching the volatility is to set

u = e

t t

d = 1 u = e

where is the volatility and t is the length of the time step. This is the approach used by Cox, Ross, and Rubinstein

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.20

ad ud a = e rt for a nondividend paying stock p= a = e( r q ) t for a stock index where q is the dividend yield on the index a=e

( r r f ) t

Fundamentals of Futures and Options Markets, 6th Edition, Copyright John C. Hull 2007

11.21

- Indian Derivative Market - Final TnrCargado porGautam Jaiswal
- BAM DD 2017-01-01Cargado porMike Dever
- Complete English PresentationCargado portienpham19893172
- 1st Time QuizzCargado porViviane Filgueiras Evangelista
- Financial RiskCargado porSana Ur Rehman
- Pgdba - Fin - Sem III - Capital MarketsCargado porapi-3762419
- 08_chapter 1-converted.docxCargado porRakesh Yadav
- Topic 1 Intro to Derivatives & FRM.mechanics of Future MktsCargado porAnshul Sharma
- financial derivativesCargado porAmit Mishra
- Derivatives-Market-1.pdfCargado porRaksha Thakur
- Homework 2Cargado pornoreen1009
- Risk Management SyllabusCargado porNguyễn Hoài Ân
- OFD Question PapersCargado porLeo Deepak
- Derivatives BSAF2K15Cargado porkhan
- hedging 2Cargado porFranz Lyn
- Interview QuestionsCargado porHaydee LaBarge
- Ch21-DerivaTIFCargado porEliza Noviriani
- Lecture 1 - Course Overview Ppt (1)Cargado porGifzy Sitthisiriporn
- jjjjjjjjjjjCargado porSamrat Kamboj
- Forex Derivatives & FuturesCargado porKirubhakaran
- DerivativeCargado porJayesh Patil
- Exposé Sur Les Produits DérivésCargado porAnonymous mmbK7QLyh
- u34iCargado porkingme157
- Derivatives Project MIHIRCargado porYogesh Kamble
- Article on DerivativesTradingCargado porMurugan Saravanan
- ScribdCargado porPervela Bruhaspathi
- project dataCargado porShailesh Gohil
- October 25.docxCargado porrcraw87
- Derivative 1Cargado porYu Xin
- Chapter 3 - Derivative Market an OverviewCargado porHarshal More

- Midterm Exam Review FNCE 254Cargado porphoebec-2
- The Correct Writing of a Lesson Plan Year 6 RPHCargado porNor Azwan Nasrudin
- Michael Hamburger - Edwin Muir.pdfCargado porFreeway4321
- Square Root of 2Cargado porAlex Lee
- Sylvia PlathCargado porVivek Mall
- QIMP14 Doctors DirectoryCargado porShahriar Mostafa
- Sep 04 Paper 1 & 2Cargado porFarrukh Ali Khan
- The Colonnade, May 13, 1961Cargado porBobcat News
- Guidelines Stress Testing CEBSCargado porG117
- Pentecost 4th SundayCargado porTy Andor
- Assessing YouCargado porMikonbai
- A a ACargado porDaniel Eguakun
- Immediate Inference (Logic)Cargado porMaricris Avendaño Lansangan
- Lesson 08Cargado porSheikh Muhammad Abdullah Arshad Altaf Malik
- 38670_13Cargado porAprajeet Ankit Singh
- Allison Transmission 700 SeriesCargado porAnonymous yjK3peI7
- Appendix x RaysCargado porAlmaram Aljweher
- ManualCargado porJulio Cesar Carrillo Mora
- Uprading of CategoryCargado poraef
- Astragalus Root and Elderberry Fruit Extracts Enhance the IFN-β Stimulatory Effects of Lactobacillus acidophilus in Murine-Derived Dendritic Cells.pdfCargado poralmirb7
- A Consecutive Modal Pushover Procedure for Estimating the Seismic Demands of Tall BuildingsCargado porhapsea
- resume jamie m szymanski 042016 teachingCargado porapi-264266683
- ira literary analysis pre-writingCargado porapi-252344608
- 106893_105774_Eric A. Heinze - Waging Humanitarian War_ The Ethics, Law, and Politics of Humanitarian Intervention (200.pdfCargado porOlivia Dwi Nastiti
- fucking sisters hot friendCargado porgoudtsri
- King DavidCargado porGrace Teng
- 9.1. Rapid Reading - 1. a NailCargado porSaahil Ledwani
- Accounting for Business CombinationsCargado porarakeel
- A Preliminary Analysis of the Relationship Between Self-employment and Unemployment in PakistanCargado porHamid Rehman
- HuntingtonCargado porDenise Espinosa