Derivatives: Valuation and Risk Management

By David A. Dubofsky; Thomas W. Miller Jr. | Go to book overview

PREFACE

We are all in the thick of a financial revolution. Over the past 25 years, the use of financial derivatives to manage risk has evolved from an exotic practice to a commonplace occurrence. This explosive growth in derivative securities mandates that all financial managers acquire a working knowledge of these important risk management instruments. Although this book is intended for a wide range of readers, it is more than just an introduction to derivative financial securities. A first reading of this book will yield a strong working knowledge of derivative securities. A mastery of the material, however, will guarantee a thorough understanding of the substantive elements in the burgeoning field of financial derivatives.

In this book, we concentrate on four classes of derivative security contracts. These classes are forward contracts, futures contracts, swap contracts, and option contracts. The focus of this book is on using forwards, futures, swaps, and options to manage price risk. However, it is important to realize that calculating the value of a derivative is also a crucial component of risk management. Fortunately, the field of finance has just the right paradigm to allow us to study how competitive markets set prices for derivative securities. Throughout this book, we detail the use of the 'absence of arbitrage' paradigm to calculate these prices.

Studying derivative securities can often be nettlesome because the material demands that the reader have a solid understanding of concepts in several fields, namely: finance, economics, elementary probability and statistics, and, of course, mathematics. For example, in writing this book, we have assumed that the reader is familiar with basic financial topics such as the term structure of interest rates, the workings of equity and fixed income markets, and the time value of money. Then, to understand the valuation of derivatives and their use in risk management, the student of financial derivatives must be able to mix these concepts with intuition and the “absence of arbitrage” paradigm.

Undeniably, the valuation concepts presented in this book are essential underpinnings for risk management. However, the actual process of valuing derivatives, especially as they grow in complexity, is also important. Although most textbooks on derivative securities use software to help the reader understand the vagaries of these markets, we provide a unique opportunity to acquaint readers with a software product used by practitioners, FinancialCAD.*

*The software described in this book is furnished under a software license agreement. The software may be used or
copied only in accordance with the terms of the agreement. Information about the software is subject to change
without notice, and FinancialCAD and Oxford University Press MAKE NO WARRANTIES, EXPRESS OR
IMPLIED, IN THIS DOCUMENT. Software copyright notice: Copyright © 1991-2002 FinancialCAD Corpora-
tion. All rights reserved. FinancialCAD® and Fincad® are registered trademarks of FinancialCAD Corporation.
Other trademarks are the property of their respective holders.

-xxi-

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