Equity Swaps An equity swap is an OTC derivative contract in which two parties agree to exchange a series of cash flows. In this arrangement, one party pays a variable series determined by equity. The other party pays a variable…

A currency swap is an agreement between two counterparties to exchange future interest payments in different currencies. The payments can be based either on a fixed interest rate or a floating interest rate. By swapping future interest obligations, the two…

Swaps are typically derivative contracts in which two parties exchange (swap) cash flows or other financial instruments over multiple periods for a give-and-take benefit, usually to manage risk. Both swap contract parties have future obligations. Therefore, similar to forwards and…

A coupon-paying bond’s pricing and valuation are the same as those of a dividend-paying stock. The difference is that the cash flows are coupons and not dividends. Fixed income forward and futures have several problems that are related to the…

The most used interest rate in the derivatives market is the LIBOR which stands for London Interbank Offered Rate. LIBOR is the rate at which London banks can borrow from one another. When the loans are in dollars, they are…

A forward contract is a contract that promises to buy or sell an asset on a specific date in the future at a prearranged price. We need to construct a portfolio with cash flows equal to the forward to price…

A carry arbitrage model is a no-arbitrage approach where the underlying asset is either sold or bought and a forward position established. This model accounts for the cost to hold or carry the underlying instrument. The carry costs for an…

Implied Volatility We have seen that both the BSM model and Black model require the parameter, \(\sigma\), which is the volatility of the underlying asset price. However, future volatility cannot be observed directly from the market but rather estimated. One…

Reading 33: Pricing and Valuation of Forward Commitments -a. Describe the carry arbitrage model without underlying cashflows and with underlying cashflows; -b. Describe how equity forwards and futures are priced, and calculate and interpret their no-arbitrage value; -c. Describe how…

Gamma measures the risk that remains once a portfolio is delta neutral (non-linearity risk). The BSM model assumes that share prices change continuously with time. In reality, however, stock prices do not move continuously. Instead, they often jump, and this…