., 568, 573, 590Reiff, W. W., 119
Reiner, E., 450, 465, 501Reinganum, M., 64
Reis, J., 290
Rendieman, R., 64, 82, 117, 214, 428, 538, 567Rennie, A., 500
Resnick, B. G., 119, 181, 182, 342Reynolds, C. E., 683, 684Rich, D., 606
Richard, S., 65
Richardson, M., 257, 364Ritchken, P, 450, 480, 568, 590728
Rodriguez, R. J., 634
Roll, R., 251, 255, 258
Ross, S. A., 64, 68, 214, 258, 392, 428, 456, 479,487, 500, 542, 558, 567, 664
Rubinstein, M., 164, 214, 325, 342, 392, 428, 437,446, 450, 460, 473, 480
Sandmann, K., 577, 590
Sandor, R. L., 684
Sankarasubramanian, L., 450, 568, 590
Santa-Clara, P.. 586
Schaefer, S. M., 567
Schneller, M., 249
Scholes, M., 234, 249, 258, 341
Schroder, M., 480
Schultz, P., 249, 342
Schwager, J. D., 38
Schwartz, E. 8., 290, 429, 474, 480, 543, 567, 586,590, 666, 667, 675, 676
Scott, J. S., 198
Senchak, A. J., 119
Shastri, K., 342
Singleton, K., 633
Slivka, R., 198
Smith, C. W., 147, 258
Smith, D. J., 605, 606
Smith, T., 257
Smithson, C. W., 147
Sobol’, 1. M., 417, 429
Sondermann, D., 577, 590
Sosin, H., 441, 450
Spindel, M., 589
Stapleton, R. S., 429
Stegun, [., 248
Stoll, H. R., 182, 290
Strickland, C., 428, 450, 684
Stulz, R. M., 88, 450, 656
Stutzer, M., 480
Subrahmanyam, M. G., 290, 429
Sundaresan, M., 65, 290
Suo, W., 461, 486
Tandon, K., 342
Tavakoli, J. M., 656
Taylor, H. M., 229
Author Index
Taylor, S. J., 342
Telser, L. G., 64
Teukolsky, S. A.. 379, 416, 417, 429, 565
Teweles, R. J., 38
Thomas, C. P., 342
Thomson, R., 695
Tilley, J. A., 325, 474, 480
Tompkins, R., 337
Toy, W., 563, 567
Traub, J.. 429
Trevor, R., 480
Trigeorgis, L., 676
Tsiveriotis, K., 653, 656
Turnbull, S. M., 147, 444, 450, 590, 627, 633, 636,656
Ulrig-Homberg, M., 589
Vasicek, O. A., 539, 567
Veit, W. T., 119
Vetterling, W. T., 379, 416, 417, 429, 565
Vijh, A. M., 450
Viswanath, P. V., 64
Viswanathan, R., 479
Vorst, A., 443, 450
Vorst, T. C. F., 465
Wakeman, L. M., 147, 444, 450
Wall, L. D., 147
Walter, U., 589
Weber, T., 589
Welch, W. W., 198
Whalcy, R. E., 255, 256, 258, 290, 342, 427,429
White, A., 147, 318, 325, 333, 365, 406, 415, 425,428, 429, 459, 462, 472, 473, 479, 501, 546,552, 558, 560, 564, 567, 568, 571, 580, 582,585, 589, 630, 633, 641, 644, 656
Whitelaw, R., 364
Wilmott, P., 365, 429
Wolf, A., 290
Xu, X., 342
Yates, J. W., 198
Zhang, P. G., 695
Zhu, Y., 359, 365
Zou J., 606730
Bearish calendar spread, 193Bear spread, 189-90, 701Bermudan option, 436, 701Bermudan swap option, 586Beta, 82, 701changing, 84-85Bid, 2, 134-35, 157, 701Bid~-ask spread, 701iBid—offer spread, 135, 157, 158, 701Binary credit default swap, 642—43Binary option, 441, 701Binomial model, 701Binomial tree, 701alternative for constructing, 406-10American options example, 209—10control variate technique, 406defined, 200delta and, 210-11dollar dividend-paying stocks, 403-5European options examples, 200 209futures option, 284-86matching volatility, 211-12, 212-13nondividend-paying stock, 392-97one-step, 200-5, 269-70options on index, currency, and futures,399-402risk-neutral valuation and, 203-5stock paying a known dividend yield,267-70, 402-3time-dependent interest rates and, 405—6two-step, 205—10Bivariate normal distribution, 701Black Monday, 55, 322, 360, 692Black’s approximation, 701American call option, 255—56Black’s model, 701European interest rate derivatives, 508—10forward risk-neutral valuation and, 514—15,519-20, 523-24Black-Scholes bias,equity option and, 334-36foreign currency options and, 331-34single jumps in asset price anticipated,338-39Black—Scholes—Merton differential equation,241-44Black-Scholes modcl, 701cumulative normal distribution function,248-49
Subject index
delta and, 303difference between binomial tree model and,241-42dividend, 252-56known dividend yield, 268—69expected return, 237-38European option on non-dividend-payingstock, 246-48forward risk-neutral valuation and, 493-94implied volatility, 250-51, 331. See alsoVolatility smile.pricing formulas, 246-48, 268-69risk-neutral valuation and, 244-45, 247volatility, 238-41, 251-52, 330Board broker, 701Board order, 33Bolsa de Mercadorias y Futuros (BM&F), 19Bond, pricing, 94-96Bond option, 511, 701embedded, 511European, 511-13forward risk-neutral valuation and Black’smodel, 514-15valuation using Vasicek model, 540—42on coupon bearing bonds, 549-50Bond yield, 95, 701Bond yield volatilities, 513-14Bootstrap method, 96-98, 701Boston option, 436, 701Boltom straddle, 195Bottom vertical combinations, 196Boundary conditions, 243Brady Commission report, 322-23Break forward, 436, 701Brent index price, 680Brownian motion, 218Bullish calendar spread, 193Bull spread, 187-89, 701Business day conventions, 131Business valuation, 666-67Butterfly spread, 190-92, 701
Buvine on margin. 158suying On mar EM, 130
Cc
CAC-40 Index, 53
Calendar spread, 192-94, 701Calibrating instruments, 564Calibration, 564-65, 584-85, 702Callable bond, 511, 702Subject index
Call option, 6-7, 151, 702Cancelable forward, 436Cancelable swap, 603—4, 702 ~Cancelable compounding swaps, 604-5Cap, interest rate, 515-20, 702valuation, 517—18Caplet, interest rate, 516, 702Cap rate, 515, 702Capital asset pricing model, 61, 82, 273, 621,660-61, 702relation to market price of risk, 485, 487,665-66Capital investment appraisal, 660—61Cash-flow mapping, 354, 702Cash-or-nothing call, 441, 702Cash-or-nothing put, 441, 702Cash price, bond and Treasury bill, 104, 512,561. See also Dirty price.Cash settlement, 32, 702CAT bond, catastrophic bond, 683, 702Changing the measure, 212, 495-96Cheapest-to-deliver bond, 108, 702Chemical Bank, 687, 690‘Chicago Board of Trade (CBOT), 1, 5, 6, 19,21, 22, 34, 52, 104, 279, 683Chicago Board Options Exchange (C por[- —2, tl, 151, 152, 153, 154, 155 5, 157, 270,273CBOEdirect, 157Chicago Mercantile Exchange (CME), 1, 5, 19,21-22, 32, 34, 52, 53, 55, 56, 110, Ul,279, 497, 679Cholesky decomposition, 413, 702Chooser option, 438, 702Citron, Robert, 686, 688, 689, 693Claim amount, 615, 618Clean price, bond, 512, 702. See also Quotedprice.Clearing margin, 26, 702Clearinghouse, 26, 702Collar, interest rate, 517, 702Collateralization, 625Collateralized debt obligation (CDO), 646-47,702Collateralized mortgage obligation (CMO), 587,702Combination, option trading strategy, 194-96,702Commission brokers, 32, 702
731
Commission, stock option, 157-58Commodity Futures Trading Commission(CFTC), 33-34, 161, 702Commodity price, 667-70Commodity swap, 605, 702Comparative-advantage argumentinterest rate swap, 131-34currency swap, 141-43Compound option, 437, 703Compounding frequency, 42-43, 703Compounding swap, 595-98, 703Conditional VaR (C-VaR), 347-48, 703Confirmation, 130, 595, 596, 602, 703Constant elasticity of variance (CEV) model,456-57Constant maturity swap (CMS), 599-600, 703Constant maturity Treasury swap (CMT), .600-601, 703Constructive sale, 162Consumption asset, 41, 58-59, 703market price of risk, 485Contango, 31, 703Continuous compounding, 43-44, 703Continuous-time stochastic process, 216, 217-22Continuous variable, 216
Contract size, 21
Contraction option, 671
Control areas, electricity-producing region, 681
Control variate technique, variance reductionprocedure, 406, 415, 703
Convenience yield, 59 60, 703
venience yield,
Convergence arbitrage, 692
Conversion factor, 106—7, 703
Convertible bond, 163, 652-54, 703conversion ratio, 652
Convexity, 115, 117 18, 703
Convexity adjustment, 524—27, 703constant maturity swap (CMS), 600forward rates and futures rates, 111, 566LIBOR-in-arrears swap, 526, 599swap rates, 527
Cooling degree days (CDD), 679, 702
Copula, 703
Corner the market, 35
Cornish—Fisher expansion, 358, 703
Correlation, 385 88
Correlation swap, 605
Cost of carry, 60, 703
Counterparty, 703732
Coupon, 94, 703Covariance, 385—88consistency condition, 387-88updating using EWMA, 386updating using GARCH, 387Covariance swap, 605Covered call, 159-60, 703covered position, 300Crank—Nicolson scheme, 426Crashophobia, 335-36Credit default swap (CDS), 637-44, 703approximate no-arbitrage arguments, 641implying default probabilities, 641-42quotes, 638recovery tate estimates, 642valuation, 639-40Credit default swap spread (CDS spread), 640Credit derivative, 15, 637, 703adjusting price for default risk, 647-49Credit event, 637Credit rating, 610, 703Credit rating migration, 626-27Credit ratings transition matrix, 626-27, 703Credit risk, 2, 703interest rate and, 93of swaps, 145-46Credit Risk Plus, 630-31Credit spread option, 645-46, 703Credit Suisse Financial Products, 630-31Credit value at risk, 630, 704CreditMetrics, 632Cross-currency derivative, 497-99Cross gamma, 358Crude oil derivative, 680Cumulative normal distribution function,248-49, 704polynomial approximation, 248Currency forward and futures, 55-58quotation, 3, 57Currency futures option, 279Currency option, 151early exercise, 278implied distribution and lognormaldistribution, 331-33quotation, 276-77valuation, binomial ee, 399-402valuation, Black-Scholes, 276-78volatility smile, 331-34
Subject index
Currency swaps, 140-43, 598, 704comparative advantage argument, 141—43impact of default risk, 649-51to transform loans and assets, 141valuation of, 143-45
Curvature, 312
Cylinder option, 435
DDaiwa, 686, 687DAX-30 Index, 53Day count conventions, 102-3, 130, 704Day order, 33Day trader, 32-33Day trade, 26, 704Default correlation, 627-30, 704reduced-form models, 629structural models, 630Default probability, see Probability of default.Default probability density, 613-14, 704Default riskadjusting derivative prices, 647-49Deferred payment option, 436, 704Deferred swap, 521, 704Delivery, 21-22, 60-61Delivery price, 4, 704Delta, 210, 302, 704estimating, using binomial tree, 398European stock options, 210-11, 302, 303-5forward contract, 305futures contract, 305-6interest rate derivatives, 530portfolio, 308-9relationship with theta and gamma, 315-16Delta hedging, 210, 302-9, 704dynamic aspects, 306-8impact of stochastic volatility on deltahedging, 459-60performance measure, 307, 308transaction cost, 309Delta-neutral portfolio, 303, 704DerivaGem, 715-19, 704Derivative, 1, 704nonstandard, 14plain vanilla, 14standard, 14Deuische Bank, 691Diagonal spread, 194, 704Differential swap (diff swap), 601, 704Subject Index
Diffusion process, 704Dirty price, bond, 512. See also Cash price.
Discount bond, 704 “
Discount broker, 158Discount instrument, 704Discount rate, 104, 704Discrete-time stochastic process, 216, 223-25Discrete variable, 216Discretionary order, 33Diversification, 352, 689Dividend, 402, 704American Call option valuation, usingBlack-Scholes model, 254—56binomial model for stocks paying dollardividend, 402-3bounds of option prices, 178-79European option valuation, using Black—Scholes model, 252-53,stock option and, 154-55, 170, 252-56stock prices and, 154-55, 170stock splits and, 154-55Dividend yield, 704binomial tree and, 269-70, 403-5DJ Euro Stoxx 50 Index, 53-54DJ Stoxx 50 Index, 53-54Dow Jones Industrial Average (DIX), 52, 152,270, 322futures, 52, 54options, 152, 270, 273,Down-and-in call, 439, 704Down-and-in put, 440, 704Down-and-out call, 439, 704Down-and-out put, 440, 704Downgrade trigger, 625, 704Drift rate, 219, 704Duration, 704bond, 112-14bond portfolio, 115modified, 114-15Duration-based hedge ratio, 117Duration-based hedging, 116-18Duration matching, 116, 704Dynamic hedging scheme, 303, 704Dynamic options replication, 447
E
Early exercise, 8, 175-78, 179, 278, 705Earth Satellite Corporation, 679Efficient market hypothesis, 217, 705
733
Electricity derivatives, 15, 681Electronic trading, 2, 705Embedded options, 511, 705Empirical research, 705Energy derivatives, 680-82Energy prices, modeling, 681-82Equilibrium model, interest rates, 537-38, 543,705Equity swap, 601-2, 705Equivalent martingale measure result, 483,488-89Eurex, 19, 54, 157, 721Eurocurrency, 705Eurodoliar, 110, 705Eurodollar futures, 110-11, 705Eurodollar futures option, 282Eurodollar interest rate, 110, 705Euronext, 721European option, 6, 151, 705binomial trees, 200-209, 269—70, 284-86,402-5Black-Scholes model, on a non-dividend-paying stock, 246-48Black-Scholes model, on a stock paying aknown dividend yield, 268-69deita, 210-11futures option compared to spot option,288-89stock paying a known dividend, 267-70dividend-paying stock, 178-79, 252-53,267-68non-dividend-paying stock, 171—74, 246-48put—call parity, 174-75, 179, 186-87, 268,330-31risk-neutral valuation, 269EWMA, see Exponentially weighted movingaverage.Execss cost laycr, reinsurance, 683Excess-of-loss reinsurance contract, 683Exchange clearinghouse, 26Exchange option, 445, 705Exchange rates, Black~Scholes and, 331-34Exchange-traded market, 1-2difference between over-the-counter marketand, 2for options, 152, 154-55Ex-dividend date, 275, 705Executive stock option, 163, 705734
Exercise boundary parametrization approach,Monte Carlo simulation, 477-78Exercise date, 6Exercise limit, 155, 705Exercise price, 6, 705Exotic option, 14, 163, 435, 705Exatics, 14Expansion option, 671Expectations theory, shape of zero curve, 102,705Expected default losses on bonds, 611-12Expected future price, 31Expected return, stock’s, 237-38stock option price and, 203Expected value of a variable, 705Expiration date, 6, 152, 705Explicit finite difference method, 422 23, 705relation to trinomial tree approach, 424-25Exponential weighting, 705Exponentially weighted moving average(EWMA), 374-75, 705compared with GARCH, 377-78estimating parameters, maximum likelihoodmethods, 380Exposure, 705Extendable bond, 705Extendable swap, 705
FFactor, 705Factor analysis, 705Facior loading, 361Factor score, 361FASB Statement No. 133, 35FBI, 34Federal National Mortgage Association(FNMA), 586Federal Reserve Board, 34Fill-or-kill order, 33Financial Accounting Standards Board (FASB),35, 706Statement No. 133, 35Financial intermediary, 129-30, 706Finite difference method, 418-27, 706applications of, 427explicit, 422-23implicit, 418-21other, 426-27relation to trinomial tree approach, 424-26
Subject Index
First notice day, 32First-to-default basket credit default swap, 643Flat volatility, 518-19, 706Flex option, 154, 273, 706Flexi cap, 581Flexible forwards, 14-15, 435Flight ta quality, 692Floor, interest rate, 517, 706valuation, 517-18Floor—ceiling agreement, see Collar.Floorlets, interest rate, 517Foreign currency option, 706. See also Currencyoption.Forward band, 435Forward contract, 2-5, 125, 706delivery, 60delivery price, 4delta, 305difference between futures and, 6, 19, 36-37difference between options and, 6, 151foreign exchange quotes, 3, 37hedging, using, 11valuing, 49-50, 226-27Forward difference approximation, 419Forward exchange rate, 706Forward induction, 460-61Forward interest rate, 98-100, 111, 566, 706volatilities, 579Forward price, 4, 5, 706for an investment asset that provides aknown cash income, 47-49for an investinent asset that provides aknown yield, 49for an investment asset that provides noincome, 45—47It6’s lemma, applied to, 226-27relation to futures price, 51-52risk-neutral valuation, 245—46Forward-rate agreement (FRA), 100-101, 706Forward risk-neutral valuation, 489, 524Black-Scholes formula to price Europeanstock options and, 493-94,bond option, 514-15interest rate caps, 519-20option to exchange one asset for another,494-95swap options, 523-24Forward risk-neutral world, 489, 706Forward start option, 437, 706Subject Index
735
 
Forward swap, 521, 706Forward with optional exit, 436Front office, 690 -FTSE 100 Index, 53Full-service broker, 158Futures contract, 5-6, 706asset underlying, 20-21closing out positions, 20commoditics, 58-61contract size, 21currencies, 55-58delivery, 21-22, 31-32, 60-61delivery month, 22, 77delta, 