Introduction to Derivative Financial Instruments: Bonds, Swaps, Options, and Hedging Book

Preface     xi
Innovation in Finance Through Derivative Instruments
Financial Innovation     3
Service Science     3
Motivation for Financial Innovation     5
The Technology Side of Service Science     8
Entrepreneurship     12
Paper Ships: A Case Study     16
Forward Freight Agreements and the Macromarkets     19
Risk Management     22
Derivatives     29
Derivatives Definition by the FASB     29
Derivatives Definition by the IASB     33
Notional Principal Amount and Underlying     35
Options, Futures, Forwards, and Swaps in a Nutshell     39
Exotic Derivatives     43
Synthetic Financial Instruments     45
Structured Financial Instruments     49
Strategic Use of Derivatives     53
Capitalizing on Creativity     53
The Customization of Financial Products     56
Over-the-Counter Derivatives Transactions     59
Risk Appetite and Risk Aversion     63
Learning a Lesson from George Soros     67
Learning a Lesson from Henry Kaufman     69
High Technology for Processes and Products     72
Hedging     75
The Search for Effective Hedges     75
Hedging Practices     78
Types of Hedging Instruments     82
Right and Wrong Hedges     84
Management Intent     88
Hedge Accounting     91
Beware of Assumed Exposure and Illiquidity
Liquidity, Solvency, and Derivatives Exposure     97
Liquidity and Solvency     97
A Quadrillion in Derivatives Exposure     100
Unexpected Consequences     104
The Criticality of Market Positions     108
Free Fall of the Bond Market in 1994: A Case Study     111
Bubbles and Ponzi Games     113
Impact of Megamergers on Exposure     116
The Daunting Task of Capital Adequacy     121
Capital Adequacy Dynamics     121
Management Accounting for Recognized but Not Realized Gains and Losses     124
Capital at Risk and Level of Confidence     128
Quantitative Impact Studies, and Second Thoughts about Capital Adequacy     133
Basel II's Unexpected Headwinds     136
The Effect of Leveraging on Capital Adequacy     141
The Origin of Legislation for Marking-to-Market     144
Options
The Use of Options     149
The Strategic Use of Options     149
Intrinsic Value and Time Value     152
Styles of Options: American, European, Asian, and Others     155
Complex Options     158
Straddles, Strangles, and Butterflies     162
Interest Rate, Yield-Based, and Foreign Currency Options     165
Option Spreading; Long Calls, Short Calls     169
Option Hedges     172
Risks Associated with Options     175
The Pricing of Options     179
Pricing Derivatives: A General Perspective     179
Object of Prediction and Effect of Volatility     182
Options Premiums and Options Pricing     186
Binomial and Lognormal Models     189
The Black-Scholes Model     194
Advantages and Shortcomings of the Black-Scholes Model     197
Testing the Black-Scholes Model     200
Option Traders, Buyers, and Writers     203
Trading Derivative Instruments     203
Options Trading     206
Flexibly Structured Options     209
Buyers' Strategies     211
Writing Options     214
Trading in Synthetic Options     217
Spreads Trading     219
Exercise, Settlement, and Technical Support      222
Risk Control for Options
The Greeks: Delta, Gamma, Theta, Kappa, Rho     227
The Challenge of Measuring Risk and Return     227
The Greeks in a Nutshell     230
Delta Hedging     233
Gamma Hedging     237
Theta, Kappa, Rho     239
Credit Risk and Market Risk with Options     243
Selling Market Risk and Buying Credit Risk     243
Market Risk Control in a Nutshell     246
GM's Put Options for Fiat Auto: A Case Study     250
Credit Risk Control in a Nutshell     251
Credit Improvement and Credit Deterioration     254
The Mispricing of Credit Risk     257
Credit-Risk-Free Debt Options     261
Credit Spreads and Credit Options     264
Futures, Forwards, and Swaps
Futures and Forwards     271
Futures, Forwards, and the Investor     271
Futures and Margin Requirements     274
Futures Trading: A Case Study with Oil     276
Price Discovery through Futures     279
Forward Contracts     282
Forward Positions: An Example with FRAs     285
Synthetic Futures     289
Warrants     290
Swaps      295
Swaps Defined     295
Players, Milestones, and Flavors of Standard Swaps     298
Interest Rate Swaps     301
Swap Spreads     303
Swaptions     305
Asset Swaps and Equity Swaps     308
Total Return Swaps     311
Credit Default Swaps     313
Differential Swaps     316
Risks Assumed with Swaps     318
Interest Rate Risk Management through Derivatives     321
Being Ahead of the Interest Rate Curve     321
The Term Structure of Interest Rates     325
The Contribution of Interest Rate Derivatives     329
Accounting for Interest Rate Derivatives     332
Internal Interest Rate Swaps     334
The Synergy between Interest Rates and Currency Rates     338
Interest Rate Risk and Its Measurement     342
Interest Rate Spreads Associated with Credit Risk     345
Index     349