Derivatives Essentials

An Introduction to Forwards, Futures, Options and Swaps

Aron Gottesman

• Publisher: Wiley
• Year: 2016
• ISBN:
  9781119163565
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Gestión de riesgos financieros

A clear, practical guide to working effectively with derivative securities products

Derivatives Essentials is an accessible, yet detailed guide to derivative securities. With an emphasis on mechanisms over formulas, this book promotes a greater understanding of the topic in a straightforward manner, using plain-English explanations. Mathematics are included, but the focus is on comprehension and the issues that matter most to practitioners—including the rights and obligations, terms and conventions, opportunities and exposures, trading, motivation, sensitivities, pricing, and valuation of each product. Coverage includes forwards, futures, options, swaps, and related products and trading strategies, with practical examples that demonstrate each concept in action. The companion website provides Excel files that illustrate pricing, valuation, sensitivities, and strategies discussed in the book, and practice and assessment questions for each chapter allow you to reinforce your learning and gauge the depth of your understanding.

Derivative securities are a complex topic with many "moving parts, " but practitioners must possess a full working knowledge of these products to use them effectively. This book promotes a truly internalized understanding rather than rote memorization or strict quantitation, with clear explanations and true-to-life examples.

• Understand the concepts behind derivative securities
• Delve into the nature, pricing, and offset of sensitivities
• Learn how different products are priced and valued
• Examine trading strategies and practical examples for each product

Pricing and valuation is important, but understanding the fundamental nature of each product is critical—it gives you the power to wield them more effectively, and exploit their natural behaviors to achieve both short- and long-term market goals. Derivatives Essentials provides the clarity and practical perspective you need to master the effective use of derivative securities products.

Part One

Introduction to Forwards, Futures, and Options

Chapter 1
Forwards and Futures

INTRODUCTION

A derivative security is an agreement between two counterparties whose payoff depends on the value of an underlying asset. In this chapter we will explore agreements that obligate counterparties to transact in the future, known as forward contracts and futures contracts.

After you read this chapter you will be able to

• Describe the key characteristics of a forward.
• Define and contrast the concepts of payoff and P&L.
• Describe a forward's cash flows, payoff, and P&L.
• Understand how equations and P&L diagrams can be used to describe a forward's cash flows.
• Understand when forwards earn profits, suffer losses, and break even.
• Explain why forwards are zero-sum games.
• Define counterparty credit risk and understand mechanisms through which it is managed and minimized.
• Describe futures contracts.
• Compare and contrast forwards and futures.

1.1 FORWARD CONTRACT CHARACTERISTICS

A forward contract is an agreement between two counterparties that obligates them to transact in the future. The key characteristics of a forward are as follows:

• One of the counterparties is referred to as the “long position” or “long forward,” and the other counterparty is referred to as the “short position” or “short forward.”
• The long forward is obligated to purchase an asset from the short forward at a future point in time. The short forward is obligated to sell the asset.
• The asset is known as the “underlying asset.” The underlying asset can be any asset. Common examples include stocks, bonds, currencies, and commodities.
• The future point in time when the transaction occurs is known as the “expiration date.” For example, a forward may have an expiration date that is three months after initiation.
• The price at which the underlying asset is purchased is called the “forward price.” The forward price is set at initiation though the transaction only takes place in the future. For example, at initiation two counterparties may agree to a forward price of $100 a...