By Chia Tan
Lately, derivatives were inaccurately labelled the monetary guns of mass destruction accountable for the worst monetary predicament in contemporary background. Inherently advanced and threatening for the ill-informed funding expert they could even though even be gainfully harnessed.
This ebook is a pragmatic advisor to the complexities of unique items written basically according to the idea that derivatives will not be homogenous, and never unavoidably dangerous.
By exploring universal issues in the back of the development of assorted based items in rates of interest, equities and foreign currency, and investigating the commercial atmosphere that promoted the explosive development of those items, this e-book can assist readers make experience in their relevance during this interval of financial uncertainty. for that reason, through explaining unique items with uncomplicated arithmetic, it's going to relief readers in figuring out their strength use in sure funding techniques when having a company keep an eye on over risk.
Exotic items needn't be inaccessible. via knowing the goods on hand traders could make trained judgements making sure positive aspects are in line with their funding goals and danger personal tastes. writer Chia Chiang Tan takes readers throughout the hazards and rewards of every product, illustrating while items can harm funding techniques and the way to prevent them, resulting in compatible, ecocnomic investments.
Ultimately, this publication will supply practitioners with an figuring out of derivatives, permitting them to figure out for themselves which items will healthy their funding approach, and the way to exploit them according to the industrial atmosphere and inherent risks.
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Extra resources for Demystifying Exotic Products: Interest Rates, Equities and Foreign Exchange
Example text
4 shows, buying 1 call and selling 1 put gives the stock minus the strike at expiry. Hence, at time t, the equation above holds (where we had to discount the strike appropriately). For completeness, it is worth mentioning that an American option is one where the holder can exercise at any date prior to expiry. The natural question is: How much are options worth? Derivatives pricing is about valuation of such and other instruments. In this chapter, we shall see the main ideas involved in the valuation of such instruments.
Counterparty Risk A final point to consider as a hedger is that the hedge is only as good as the counterparty’s solvency. When Lehman Brothers went bankrupt, various pension funds that purchased pro tection via Liability Directed Investing strategies set up by Lehman, found these hedges to be no longer applicable. Admittedly counterparty risk is something that yield investors also face, but for hedgers, a failed counterparty can mean a sudden huge exposure. For instance, if you buy a forward contract for a certain quantity of oil at a strike of $50, you would usually not take any further precautionary measures as oil prices increase (to $90 say).
Instead, investors think the forward FX rate would stay closer to spot. This leads to the carry trade: specifically, borrow yen at a low interest rate and invest in dollars at a higher interest rate. As long as yen does not ap preciate against the dollar, you earn the interest rate differential. When yen appreciated sharply in late 2007 to 2008 following the flight to safety induced by the credit crisis, the unwinding of the carry trade contributed to an even bigger rise in the yen (to just under 90 at the beginning of 2009).