By Phelim P. Boyle (Editor), Feidhilm Boyle (Editor)
This identify units out to equip the lay reader with a transparent and thorough rationalization of economic derivatives and the way they paintings. It gains an creation to the full realm of derivatives, utilizing quite a number actual lifestyles examples to supply a wide outlook at the subject material that's worldwide in standpoint. It additionally offers a lucid conceptual heritage to derivatives via warding off unecessary technical info.
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Extra info for Derivatives : The Tools That Changed Finance
Until now, we have implicitly assumed that one of the following two events must occur: either Williams wins the match or Hingis wins the match. There is another possibility that has not been discussed yet: the tennis match might not take place for some reason. If we factor in this possibility what happens to the arbitrage argument? To explore this issue we note that unlikely outcomes sometimes do occur. The US presidential election in 2000 provides a striking example. The results were to be announced on 7 November.
We now show that this approach enables us to find the contract price. From the no-arbitrage rule we know that the initial market price of the replicating portfolio must be equal to the initial market value of the forward contract. However, we know the initial market value of the forward contract. When a forward contract is set up it is designed so that it does not favour either party, there is no cash transferred at inception and the initial market value of the contract is zero. By the no-arbitrage rule, the initial market value of the portfolio that replicates the forward contract is also zero.
Security 92 pays one unit if the Dow Jones index is at 92 in one month and zero for other index levels. If the index does end up at 92 our put will then be worth eight and a package of eight units of Security 92 would also be worth eight if the index level were 92. There are in total, 100 index levels that lead to a positive put value at maturity. We can construct a package of Arrow-Debreu securities that will have precisely the same value as the put. This package consists of one unit of Security 99, two units of Security 98, three units of Security 97 and so on.