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1
Forward Contracts
2
Analysis of Forward Contracts
Using standard notation, let K be the delivery price or “strike price”, at
time T , and let Xt be the value of the underlying.
3
Derivatives: Basics
– asset
∗ investment
∗ consumable
∗ income producing
4
Derivatives: Basics
5
Types of Derivatives
These variations on the basic forward contract are all interesting. Only a
few of them are actually available.
Some variations are much easier to analyze than others. The simple ones
are interesting for classroom analyses and they may provide useful
approximations for derivatives that are actually available.
For all of them there is a ready market (always) through a third party, and
short sales are possible.
Therefore, a long position is a right and a short position (in the derivative)
is an obligation. The right “expires” at the settlement date.
6
Derivatives That Have Markets
• Stock options
• Index options
• Commodity futures
• Rate futures
7
Uses
8
Types of Common Derivatives
The variations depend on the nature of the underlying.
9
U.S. Stock Options
All (almost all) options are initiated with and through the
Options Clearing Corporation, owned by the exchanges and
headquartered on LaSalle St.
10
Analysis of Stock Options
The profit is the difference between the payoff and the price
paid.
profit
6 profit
6
@
@
@
@
@
@
@
K - @ K -
0 0 @
@
X X
12
Market Models for Derivative Pricing