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List of Business Snapshots |
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xvii | |
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xviii | |
Preface |
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xix | |
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1 | (23) |
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1.1 Exchange-traded markets |
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2 | (1) |
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1.2 Over-the-counter markets |
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3 | (3) |
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6 | (2) |
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8 | (1) |
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8 | (3) |
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11 | (1) |
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11 | (3) |
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14 | (2) |
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16 | (1) |
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17 | (7) |
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18 | (1) |
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19 | (1) |
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19 | (2) |
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21 | (3) |
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Chapter 2 Mechanics of futures markets |
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24 | (25) |
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24 | (2) |
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2.2 Specification of a futures contract |
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26 | (2) |
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2.3 Convergence of futures price to spot price |
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28 | (1) |
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2.4 The operation of margin accounts |
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29 | (3) |
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32 | (3) |
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35 | (3) |
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38 | (1) |
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2.8 Types of traders and types of orders |
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39 | (1) |
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40 | (1) |
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41 | (2) |
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2.11 Forward vs. futures contracts |
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43 | (6) |
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44 | (1) |
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45 | (1) |
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45 | (2) |
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47 | (2) |
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Chapter 3 Hedging strategies using futures |
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49 | (28) |
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49 | (2) |
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3.2 Arguments for and against hedging |
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51 | (3) |
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54 | (4) |
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58 | (4) |
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62 | (6) |
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68 | (9) |
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70 | (1) |
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70 | (1) |
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71 | (2) |
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73 | (2) |
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Appendix: Capital asset pricing model |
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75 | (2) |
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77 | (27) |
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77 | (2) |
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4.2 Measuring interest rates |
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79 | (3) |
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82 | (1) |
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82 | (2) |
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4.5 Determining Treasury zero rates |
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84 | (2) |
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86 | (2) |
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4.7 Forward rate agreements |
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88 | (3) |
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91 | (4) |
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95 | (1) |
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4.10 Theories of the term structure of interest rates |
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96 | (8) |
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98 | (1) |
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99 | (1) |
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99 | (3) |
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102 | (2) |
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Chapter 5 Determination of forward and futures prices |
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104 | (28) |
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5.1 Investment assets vs. consumption assets |
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104 | (1) |
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105 | (1) |
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5.3 Assumptions and notation |
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106 | (1) |
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5.4 Forward price for an investment asset |
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107 | (3) |
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110 | (2) |
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112 | (1) |
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5.7 Valuing forward contracts |
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112 | (2) |
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5.8 Are forward prices and futures prices equal? |
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114 | (1) |
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5.9 Futures prices of stock indices |
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115 | (2) |
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5.10 Forward and futures contracts on currencies |
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117 | (3) |
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5.11 Futures on commodities |
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120 | (3) |
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123 | (1) |
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124 | (1) |
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5.14 Futures prices and expected future spot prices |
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124 | (8) |
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126 | (2) |
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128 | (1) |
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128 | (2) |
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130 | (2) |
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Chapter 6 Interest rate futures |
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132 | (20) |
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6.1 Day count and quotation conventions |
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132 | (3) |
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6.2 Treasury bond futures |
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135 | (5) |
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140 | (5) |
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6.4 Duration-based hedging strategies using futures |
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145 | (2) |
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6.5 Hedging portfolios of assets and liabilities |
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147 | (5) |
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147 | (1) |
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148 | (1) |
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148 | (2) |
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150 | (2) |
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152 | (33) |
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7.1 Mechanics of interest rate swaps |
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153 | (5) |
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158 | (1) |
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159 | (1) |
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7.4 The comparative-advantage argument |
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159 | (4) |
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7.5 The nature of swap rates |
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163 | (1) |
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7.6 Determining the LIBOR/swap zero rates |
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164 | (1) |
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7.7 Valuation of interest rate swaps |
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164 | (4) |
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7.8 Term structure effects |
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168 | (1) |
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7.9 Fixed-for-fixed currency swaps |
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168 | (4) |
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7.10 Valuation of fixed-for-fixed currency swaps |
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172 | (3) |
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7.11 Other currency swaps |
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175 | (1) |
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176 | (2) |
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7.13 Other types of swaps |
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178 | (7) |
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180 | (1) |
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181 | (1) |
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181 | (2) |
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183 | (2) |
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Chapter 8 Securitization and the credit crisis of 2007 |
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185 | (15) |
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185 | (4) |
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8.2 The US housing market |
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189 | (4) |
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193 | (2) |
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195 | (5) |
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196 | (1) |
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197 | (1) |
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198 | (1) |
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198 | (2) |
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Chapter 9 OIS discounting, credit issues, and funding costs |
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200 | (13) |
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200 | (2) |
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202 | (3) |
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9.3 Valuing swaps and FRAs with OIS discounting |
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205 | (1) |
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9.4 OIS vs. LIBOR: Which is correct? |
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206 | (1) |
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9.5 Credit risk: CVA and DVA |
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207 | (2) |
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209 | (4) |
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210 | (1) |
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211 | (1) |
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211 | (1) |
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212 | (1) |
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Chapter 10 Mechanics of options markets |
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213 | (21) |
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213 | (2) |
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215 | (2) |
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217 | (1) |
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10.4 Specification of stock options |
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218 | (5) |
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223 | (1) |
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223 | (1) |
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224 | (2) |
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10.8 The options clearing corporation |
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226 | (1) |
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227 | (1) |
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227 | (2) |
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10.11 Warrants, employee stock options, and convertibles |
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229 | (1) |
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10.12 Over-the-counter options markets |
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229 | (5) |
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230 | (1) |
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231 | (1) |
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231 | (1) |
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232 | (2) |
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Chapter 11 Properties of stock options |
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234 | (20) |
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11.1 Factors affecting option prices |
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234 | (4) |
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11.2 Assumptions and notation |
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238 | (1) |
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11.3 Upper and lower bounds for option prices |
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238 | (3) |
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241 | (4) |
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11.5 Calls on a non-dividend-paying stock |
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245 | (1) |
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11.6 Puts on a non-dividend-paying stock |
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246 | (3) |
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249 | (5) |
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250 | (1) |
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251 | (1) |
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251 | (2) |
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253 | (1) |
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Chapter 12 Trading strategies involving options |
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254 | (20) |
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12.1 Principal-protected notes |
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254 | (2) |
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12.2 Trading an option and the underlying asset |
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256 | (2) |
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258 | (8) |
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266 | (3) |
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269 | (5) |
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270 | (1) |
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271 | (1) |
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271 | (1) |
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272 | (2) |
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Chapter 13 Binomial trees |
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274 | (28) |
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13.1 A one-step binomial model and a no-arbitrage argument |
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274 | (4) |
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13.2 Risk-neutral valuation |
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278 | (2) |
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13.3 Two-step binomial trees |
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280 | (3) |
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283 | (1) |
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284 | (1) |
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285 | (1) |
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13.7 Matching volatility with u and d |
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286 | (2) |
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13.8 The binomial tree formulas |
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288 | (1) |
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13.9 Increasing the number of steps |
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288 | (1) |
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289 | (1) |
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13.11 Options on other assets |
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290 | (12) |
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293 | (1) |
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294 | (1) |
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295 | (1) |
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296 | (2) |
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Appendix: Derivation of the Black--Scholes--Merton option-pricing formula from a binomial tree |
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298 | (4) |
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Chapter 14 Wiener processes and Ito's lemma |
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302 | (19) |
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302 | (1) |
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14.2 Continuous-time stochastic processes |
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303 | (5) |
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14.3 The process for a stock price |
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308 | (3) |
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311 | (1) |
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14.5 Correlated processes |
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312 | (1) |
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313 | (1) |
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14.7 The lognormal property |
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314 | (7) |
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315 | (1) |
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316 | (1) |
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316 | (1) |
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317 | (2) |
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Appendix: Derivation of Ito's lemma |
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319 | (2) |
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Chapter 15 The Black--Scholes--Merton model |
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321 | (33) |
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15.1 Lognormal property of stock prices |
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322 | (1) |
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15.2 The distribution of the rate of return |
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323 | (1) |
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324 | (1) |
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325 | (4) |
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15.5 The idea underlying the Black--Scholes--Merton differential equation |
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329 | (2) |
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15.6 Derivation of the Black--Scholes--Merton differential equation |
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331 | (3) |
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15.7 Risk-neutral valuation |
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334 | (1) |
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15.8 Black--Scholes--Merton pricing formulas |
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335 | (3) |
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15.9 Cumulative normal distribution function |
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338 | (1) |
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15.10 Warrants and employee stock options |
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339 | (2) |
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15.11 Implied volatilities |
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341 | (2) |
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343 | (11) |
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346 | (1) |
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347 | (1) |
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348 | (2) |
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350 | (2) |
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Appendix: Proof of Black--Scholes--Merton formula using risk-neutral valuation |
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352 | (2) |
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Chapter 16 Employee stock options |
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354 | (13) |
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16.1 Contractual arrangements |
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354 | (2) |
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16.2 Do options align the interests of shareholders and managers? |
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356 | (1) |
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357 | (1) |
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358 | (5) |
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363 | (4) |
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364 | (1) |
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365 | (1) |
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365 | (1) |
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366 | (1) |
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Chapter 17 Options on stock indices and currencies |
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367 | (16) |
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17.1 Options on stock indices |
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367 | (2) |
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369 | (3) |
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17.3 Options on stocks paying known dividend yields |
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372 | (2) |
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17.4 Valuation of European stock index options |
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374 | (3) |
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17.5 Valuation of European currency options |
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377 | (1) |
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378 | (5) |
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379 | (1) |
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379 | (1) |
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380 | (2) |
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382 | (1) |
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Chapter 18 Futures options |
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383 | (16) |
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18.1 Nature of futures options |
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383 | (3) |
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18.2 Reasons for the popularity of futures options |
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386 | (1) |
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18.3 European spot and futures options |
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386 | (1) |
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387 | (1) |
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18.5 Bounds for futures options |
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388 | (1) |
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18.6 Valuation of futures options using binomial trees |
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389 | (2) |
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18.7 Drift of a futures prices in a risk-neutral world |
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391 | (1) |
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18.8 Black's model for valuing futures options |
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392 | (2) |
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18.9 American futures options vs. American spot options |
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394 | (1) |
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18.10 Futures-style options |
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394 | (5) |
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395 | (1) |
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396 | (1) |
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396 | (1) |
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397 | (2) |
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Chapter 19 The Greek letters |
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399 | (32) |
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399 | (1) |
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19.2 Naked and covered positions |
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400 | (1) |
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19.3 A stop-loss strategy |
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400 | (2) |
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402 | (7) |
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409 | (2) |
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411 | (3) |
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19.7 Relationship between delta, theta, and gamma |
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414 | (1) |
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415 | (2) |
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417 | (1) |
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19.10 The realities of hedging |
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418 | (1) |
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419 | (1) |
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19.12 Extension of formulas |
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419 | (3) |
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19.13 Portfolio insurance |
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422 | (2) |
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19.14 Stock market volatility |
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424 | (7) |
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424 | (2) |
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426 | (1) |
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426 | (2) |
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428 | (2) |
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Appendix: Taylor series expansions and hedge parameters |
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430 | (1) |
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Chapter 20 Volatility smiles |
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431 | (19) |
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20.1 Why the volatility smile is the same for calls and puts |
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431 | (2) |
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20.2 Foreign currency options |
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433 | (3) |
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436 | (1) |
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20.4 Alternative ways of characterizing the volatility smile |
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437 | (1) |
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20.5 The volatility term structure and volatility surfaces |
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438 | (1) |
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439 | (1) |
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20.7 The role of the model |
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440 | (1) |
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20.8 When a single large jump is anticipated |
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440 | (10) |
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442 | (1) |
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443 | (1) |
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443 | (2) |
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445 | (2) |
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Appendix: Determining implied risk-neutral distributions from volatility smiles |
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447 | (3) |
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Chapter 21 Basic numerical procedures |
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450 | (44) |
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450 | (8) |
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21.2 Using the binomial tree for options on indices, currencies, and futures contracts |
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458 | (2) |
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21.3 Binomial model for a dividend-paying stock |
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460 | (5) |
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21.4 Alternative procedures for constructing trees |
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465 | (3) |
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21.5 Time-dependent parameters |
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468 | (1) |
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21.6 Monte Carlo simulation |
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469 | (6) |
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21.7 Variance reduction procedures |
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475 | (3) |
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21.8 Finite difference methods |
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478 | (16) |
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488 | (1) |
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489 | (1) |
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490 | (2) |
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492 | (2) |
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494 | (27) |
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494 | (3) |
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22.2 Historical simulation |
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497 | (4) |
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22.3 Model-building approach |
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501 | (3) |
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504 | (5) |
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509 | (2) |
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22.6 Monte Carlo simulation |
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511 | (1) |
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22.7 Comparison of approaches |
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512 | (1) |
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22.8 Stress testing and back testing |
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513 | (1) |
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22.9 Principal components analysis |
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513 | (8) |
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517 | (1) |
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517 | (1) |
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518 | (1) |
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519 | (2) |
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Chapter 23 Estimating volatilities and correlations |
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521 | (23) |
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23.1 Estimating volatility |
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521 | (2) |
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23.2 The exponentially weighted moving average model |
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523 | (2) |
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23.3 The GARCH (1, 1) model |
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525 | (1) |
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23.4 Choosing between the models |
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526 | (1) |
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23.5 Maximum likelihood methods |
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527 | (5) |
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23.6 Using GARCH (1, 1) to forecast future volatility |
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532 | (3) |
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535 | (3) |
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23.8 Application of EWMA to four-index example |
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538 | (6) |
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540 | (1) |
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540 | (1) |
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540 | (2) |
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542 | (2) |
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544 | (27) |
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544 | (1) |
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24.2 Historical default probabilities |
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545 | (1) |
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546 | (1) |
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24.4 Estimating default probabilities from bond yield spreads |
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547 | (3) |
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24.5 Comparison of default probability estimates |
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550 | (3) |
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24.6 Using equity prices to estimate default probabilities |
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553 | (2) |
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24.7 Credit risk in derivatives transactions |
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555 | (6) |
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561 | (3) |
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564 | (7) |
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567 | (1) |
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567 | (1) |
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568 | (1) |
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569 | (2) |
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Chapter 25 Credit derivatives |
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571 | (27) |
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25.1 Credit default swaps |
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572 | (3) |
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25.2 Valuation of credit default swaps |
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575 | (4) |
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579 | (1) |
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25.4 The use of fixed coupons |
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580 | (1) |
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25.5 CDS forwards and options |
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581 | (1) |
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25.6 Basket credit default swaps |
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581 | (1) |
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581 | (2) |
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25.8 Collateralized debt obligations |
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583 | (2) |
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25.9 Role of correlation in a basket CDS and CDO |
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585 | (1) |
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25.10 Valuation of a synthetic CDO |
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585 | (7) |
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25.11 Alternatives to the standard market model |
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592 | (6) |
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594 | (1) |
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594 | (1) |
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595 | (1) |
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596 | (2) |
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Chapter 26 Exotic options |
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598 | (26) |
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598 | (1) |
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26.2 Perpetual American call and put options |
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599 | (1) |
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26.3 Nonstandard American options |
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600 | (1) |
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601 | (1) |
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26.5 Forward start options |
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602 | (1) |
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602 | (1) |
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602 | (1) |
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603 | (1) |
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604 | (2) |
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606 | (1) |
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607 | (2) |
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609 | (1) |
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609 | (2) |
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26.14 Options to exchange one asset for another |
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611 | (1) |
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26.15 Options involving several assets |
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612 | (1) |
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26.16 Volatility and variance swaps |
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613 | (3) |
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26.17 Static options replication |
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616 | (8) |
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618 | (1) |
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619 | (1) |
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619 | (2) |
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621 | (3) |
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Chapter 27 More on models and numerical procedures |
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624 | (31) |
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27.1 Alternatives to Black--Scholes--Merton |
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625 | (5) |
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27.2 Stochastic volatility models |
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630 | (2) |
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632 | (1) |
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633 | (3) |
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27.5 Path-dependent derivatives |
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636 | (4) |
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640 | (3) |
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27.7 Options on two correlated assets |
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643 | (3) |
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27.8 Monte Carlo simulation and American options |
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646 | (9) |
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650 | (1) |
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651 | (1) |
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652 | (1) |
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653 | (2) |
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Chapter 28 Martingales and measures |
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655 | (18) |
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28.1 The market price of risk |
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656 | (3) |
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28.2 Several state variables |
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659 | (1) |
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660 | (1) |
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28.4 Alternative choices for the numeraire |
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661 | (4) |
|
28.5 Extension to several factors |
|
|
665 | (1) |
|
28.6 Black's model revisited |
|
|
666 | (1) |
|
28.7 Option to exchange one asset for another |
|
|
667 | (1) |
|
|
668 | (5) |
|
|
669 | (1) |
|
|
670 | (1) |
|
|
670 | (2) |
|
|
672 | (1) |
|
Chapter 29 Interest rate derivatives: The standard market models |
|
|
673 | (20) |
|
|
673 | (5) |
|
29.2 Interest rate caps and floors |
|
|
678 | (6) |
|
29.3 European swap options |
|
|
684 | (4) |
|
|
688 | (1) |
|
29.5 Hedging interest rate derivatives |
|
|
688 | (5) |
|
|
689 | (1) |
|
|
690 | (1) |
|
|
690 | (1) |
|
|
691 | (2) |
|
Chapter 30 Convexity, timing, and quanto adjustments |
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|
693 | (13) |
|
30.1 Convexity adjustments |
|
|
693 | (4) |
|
|
697 | (2) |
|
|
699 | (7) |
|
|
702 | (1) |
|
|
702 | (1) |
|
|
702 | (2) |
|
|
704 | (1) |
|
Appendix: Proof of the convexity adjustment formula |
|
|
705 | (1) |
|
Chapter 31 Interest rate derivatives: models of the short rate |
|
|
706 | (34) |
|
|
706 | (1) |
|
|
707 | (7) |
|
|
714 | (5) |
|
|
719 | (1) |
|
31.5 Volatility structures |
|
|
720 | (1) |
|
|
721 | (2) |
|
31.7 A general tree-building procedure |
|
|
723 | (9) |
|
|
732 | (2) |
|
31.9 Hedging using a one-factor model |
|
|
734 | (6) |
|
|
735 | (1) |
|
|
735 | (1) |
|
|
736 | (2) |
|
|
738 | (2) |
|
Chapter 32 HJM, LMM, and multiple zero curves |
|
|
740 | (20) |
|
32.1 The Heath, Jarrow, and Morton model |
|
|
740 | (3) |
|
32.2 The LIBOR market model |
|
|
743 | (10) |
|
32.3 Handling multiple zero curves |
|
|
753 | (2) |
|
32.4 Agency mortgage-backed securities |
|
|
755 | (5) |
|
|
757 | (1) |
|
|
758 | (1) |
|
|
758 | (1) |
|
|
759 | (1) |
|
Chapter 33 Swaps Revisited |
|
|
760 | (15) |
|
33.1 Variations on the vanilla deal |
|
|
760 | (2) |
|
|
762 | (1) |
|
|
763 | (1) |
|
|
764 | (3) |
|
|
767 | (2) |
|
33.6 Swaps with embedded options |
|
|
769 | (2) |
|
|
771 | (4) |
|
|
772 | (1) |
|
|
773 | (1) |
|
|
773 | (1) |
|
|
774 | (1) |
|
Chapter 34 Energy and commodity derivatives |
|
|
775 | (17) |
|
34.1 Agricultural commodities |
|
|
775 | (1) |
|
|
776 | (1) |
|
|
777 | (2) |
|
34.4 Modeling commodity prices |
|
|
779 | (6) |
|
|
785 | (1) |
|
34.6 Insurance derivatives |
|
|
786 | (1) |
|
34.7 Pricing weather and insurance derivatives |
|
|
786 | (2) |
|
34.8 How an energy producer can hedge risks |
|
|
788 | (4) |
|
|
789 | (1) |
|
|
789 | (1) |
|
|
790 | (1) |
|
|
791 | (1) |
|
|
792 | (14) |
|
35.1 Capital investment appraisal |
|
|
792 | (1) |
|
35.2 Extension of the risk-neutral valuation framework |
|
|
793 | (2) |
|
35.3 Estimating the market price of risk |
|
|
795 | (1) |
|
35.4 Application to the valuation of a business |
|
|
796 | (1) |
|
35.5 Evaluating options in an investment opportunity |
|
|
796 | (10) |
|
|
803 | (1) |
|
|
803 | (1) |
|
|
804 | (1) |
|
|
804 | (2) |
|
Chapter 36 Derivatives mishaps and what we can learn from them |
|
|
806 | (12) |
|
36.1 Lessons for all users of derivatives |
|
|
806 | (4) |
|
36.2 Lessons for financial institutions |
|
|
810 | (5) |
|
36.3 Lessons for nonfinancial corporations |
|
|
815 | (3) |
|
|
817 | (1) |
|
|
817 | (1) |
Glossary of terms |
|
818 | (22) |
DerivaGem software |
|
840 | (5) |
Major exchanges trading futures and options |
|
845 | (1) |
Tables for N(x) |
|
846 | (1) |
Author index |
|
847 | (5) |
Subject index |
|
852 | |