Table of Contents
Chapter 1 – Introduction to Derivatives and Hedging –
Section 1............................. 7
1.1 The Concept of Risk................................................................................................................................ 7
1.2 Financial Risks.......................................................................................................................................... 8
1.2.1 Interest
rate risk........................................................................................................................................ 9
1.2.2 Credit
risk................................................................................................................................................ 10
1.2.3 Foreign
exchange risk........................................................................................................................... 10
1.2.4 Other
types of financial risk................................................................................................................. 12
Chapter 1 – Introduction to Derivatives and Hedging –
Section 2........................... 15
1.3 Financial Risk Management.......................................................................................................... 15
1.3.1 The risk
management process.............................................................................................................. 15
1.3.2 The risk
profile........................................................................................................................................ 16
1.4 Tools for Hedging Financial
Risk............................................................................................. 17
1.4.1
Asset-Liability Management................................................................................................................ 17
1.4.2
Derivative instruments.......................................................................................................................... 17
Chapter 2 – Forwards – Section 3.......................................................................................................... 21
2.1 What are Forward Contracts?.................................................................................................. 21
2.2 Forward Payoffs................................................................................................................................... 22
2.2.1 The
payoff function................................................................................................................................ 22
2.2.2 The
payoff diagram................................................................................................................................ 23
Chapter 2 – Forwards – Section 4.......................................................................................................... 27
2.3 Forward Pricing.................................................................................................................................... 27
2.3.1 The
costs and benefits of forwards..................................................................................................... 27
2.3.2 Forward
prices and arbitrage............................................................................................................. 28
2.4 Foreign Exchange Forwards........................................................................................................ 29
2.5 Forward Rate Agreements............................................................................................................ 31
Chapter 3 – Futures – Section 5.............................................................................................................. 35
3.1 What are Futures Contracts?..................................................................................................... 35
3.2 Futures Markets................................................................................................................................... 36
3.2.1 Futures
exchanges................................................................................................................................. 36
3.2.2
Standardization of contracts............................................................................................................... 37
3.2.3 Market
mechanics.................................................................................................................................. 38
3.2.4 Futures
margin....................................................................................................................................... 39
3.2.5 The
exchange clearinghouse............................................................................................................... 40
Chapter 3 – Futures – Section 6.............................................................................................................. 45
3.3 Hedging Risk using Futures........................................................................................................... 45
3.3.1 Short
hedges............................................................................................................................................ 45
3.3.2 Long
hedges............................................................................................................................................ 46
3.3.3 Basis
risk.................................................................................................................................................. 47
3.4 The Risks of Futures Trading....................................................................................................... 48
3.4.1 Hedging
vs. speculating........................................................................................................................ 48
3.4.2 The
Barings Bank disaster.................................................................................................................... 49
Chapter 4 – Swaps – Section 7.................................................................................................................... 52
4.1 Interest Rate Swaps............................................................................................................................ 52
4.1.1
Mechanics of interest rate swaps........................................................................................................ 52
4.1.2 Creating
synthetic assets and liabilities using swaps.................................................................... 55
Chapter 4 – Swaps – Section 8.................................................................................................................... 60
4.2 Currency swaps..................................................................................................................................... 60
Chapter 4 – Swaps – Section 9.................................................................................................................... 63
4.3 Credit default swaps......................................................................................................................... 63
4.4 Other Types of Swaps.......................................................................................................................... 64
4.4.1 Equity
Swaps........................................................................................................................................... 65
4.4.2 Total
Return Swaps................................................................................................................................ 65
4.4.3
Commodity Swaps.................................................................................................................................. 65
Chapter 5 – Options – Section 10............................................................................................................. 69
5.1 The Option Contract.......................................................................................................................... 69
5.1.1 Options
trading...................................................................................................................................... 69
5.1.2 Options
markets...................................................................................................................................... 70
5.1.3 The
Options Clearing Corporation (OCC)....................................................................................... 71
Chapter 5 – Options – Section 11............................................................................................................. 73
5.2 Option Payoffs........................................................................................................................................ 73
5.2.1 Long call
option..................................................................................................................................... 73
5.2.2 Long put
option...................................................................................................................................... 74
5.2.3 Short
call option.................................................................................................................................... 75
5.2.4 Short
put option..................................................................................................................................... 77
Chapter 5 – Options – Section 12............................................................................................................. 81
5.3 Option Strategies................................................................................................................................. 81
5.3.1 Covered
calls.......................................................................................................................................... 81
5.3.2 Spreads..................................................................................................................................................... 82
5.3.3
Combinations.......................................................................................................................................... 83
Review Answers.................................................................................................................................................. 87
Chapter 1 – Section 1................................................................................................................................... 87
Chapter 1 – Section 2................................................................................................................................... 91
Chapter 2 – Section 3................................................................................................................................... 94
Chapter 2 – Section 4................................................................................................................................... 97
Chapter 3 – Section 5................................................................................................................................. 100
Chapter 3 – Section 6................................................................................................................................. 105
Chapter 4 – Section 7................................................................................................................................. 107
Chapter 4 – Section 8................................................................................................................................. 111
Chapter 4 – Section 9................................................................................................................................. 114
Chapter 5 – Section 10............................................................................................................................... 116
Chapter 5 – Section 11............................................................................................................................... 118
Chapter 5 – Section 12............................................................................................................................... 122
Glossary................................................................................................................................................................ 123
Index.......................................................................................................................................................................... 129
Final Examination......................................................................................................................................... 133
CPASelfstudy.com Course Evaluation.......................................................................................... 149