An Introduction to Derivative Securities, Financial Markets, and Risk Management: 2nd Edition

772 Pages·2019·9.215 MB·English

by  Robert Jarrow, Arkadev Chatterjea

AN INTRODUCTION TO DA
eN
Derivative Securities, Financial Markets, and Risk Management r
iv IN
a
tT
iR
v
eO
FIRST EDITION ADOPTED IN MORE THAN 75 WHAT ADOPTERS ARE SAYING SD
eU
UNIVERSITIES IN 22 COUNTRIES
cC
“The text is pleasantly different from others in the market, u
Written by two of the most distinguished finance scholars in especially the clarity of the explanations provided for the rT
iI
the industry, this introductory textbook on derivatives and risk concepts involved. The teaching slides provided are the best tiO
e
management is highly accessible in terms of the concepts as I have encountered to-date.” N
s
well as the mathematics. Dr Nagaratnam Jeyasreedharan , F TO
University of Tasmania, Australia i
With its economics perspective, this rewritten and streamlined n
second edition textbook, is closely connected to real markets, a
n
and:
c
“I have read the whole book and I find it excellent. It’s a great
i
blend of theory and the ‘institutional’ aspects of derivatives a
• Shows how macroeconomic forces have shaped the l
markets trading.” M
• Explains the major derivative pricing models using algebra Professor Rafael de Santiago a
r
and introductory calculus IESE Business School, Spain k
e
• Shows students how to implement these models using basic t
s
statistics and elementary Excel spreadsheet skills ,
“This book is a great resource for a rigorous introduction to
a
• Discusses the uses of derivatives while warning against derivatives, both pricing and markets. Thanks to an elaborate n
their abuses set of detailed examples, references to relevant case studies, a d
• Presents hard-to-teach interest rate derivatives in an intuitive full set of worked solutions to problem sets and slides, using R
manner this book means reduced prep time without sacrificing the is AN INTRODUCTION TO
students’ learning experience.” k
• Presents the Heath–Jarrow–Morton model, which is the
M
most advanced derivatives pricing model, in an accessible Dr Thijs van der Heijden Derivative Securities, Financial Markets,
manner by presenting it side-by-side with classical option University of Melbourne, Australia a
n
pricing theory a
g .d
e
Bsaletnesudgsdo ieennnnnstgi snci,gna t enah ebte rae inb lpgeorv oogekfirl tagathdbraaulytda iutuse sacsel,oldy ma bdsfyo ew rbvteeaullbslo ialnpese st soM ts hl BomewA acsejoo rw nrdshti,ev oani srtwti soso,no us clctdhoie alwlnetoc giretesk, sa“bMoua tcyiht ku’osgn rrgdsor eeuhranasttvd ate onm idlneaicnatlegrun rodi aafe ldbd, eoa.”runivtd aa talilv ltleh steh h eha isis nbtoteerericen asptl uidnreegvl yea mlnoeapctmhdeeomntetasst, i ctthhaeel, ement vreser sthgir llA and Risk Management
in the finance industry. .d
e
Professor Kevin Aretz tim
University of Manchester, UK 2nd Ed. iL .e Second Edition
SUPPLEMENTARY MATERIALS tP y ROBERT JARROW
n
a
p
• Extension sections in the book feature advanced topics “This book’s interest rate derivatives chapters are some of JA moC
and current research insights not available in existing the best chapters I have read, because the authors have R gn
textbooks tphreo vbidaseidc sa, ne xoaumtsptlaensd, ianngd apnrdac dtiicsatiln acptipvleic watoiorkn sin o fte ianctehriensgt RO ihsilbuP ARKADEV CHATTERJEA
• Senodlu-otifo-cnhsa pMtearn quuael swtioithns d aentadi lperdo bsloelmutsions to nearly 500 rate derivatives and the Heath-Jarrow-MPororftoesns (oHrJ SMc)o mtt oFduenlg.” W • cifitneicS
• PowerPoint slides and a Test Bank for adopters California State University, East Bay, USA C dlro
W
H .8
A 10
2
T ©
T th
E giry
R po
C
J
E
A
World Scientific ISBN 978-1-944659-55-4
www.worldscientific.com World Scientific

Y0018 hc

Y0018_9781944659554_hc.indd All Pages 8/4/19 1:59 PM
AN INTRODUCTION TO
Derivative Securities, Financial Markets,
and Risk Management
Second Edition
This page intentionally left blank
AN INTRODUCTION TO
Derivative Securities, Financial
Markets, and Risk Management
Second Edition
ROBERT A. JARROW
Cornell University
ARKADEV CHATTERJEA
Indiana University Bloomington
World Scientific
NEW JERSEY (cid:127) LONDON (cid:127) SINGAPORE (cid:127) BEIJING (cid:127) SHANGHAI (cid:127) HONG KONG (cid:127) TAIPEI (cid:127) CHENNAI (cid:127) TOKYO
Publishedby
WorldScientificPublishingCo.Inc.
27WarrenStreet,Suite401-402,Hackensack,NJ07601,USA
Headoffice: 5TohTuckLink,Singapore596224
UKoffice: 57SheltonStreet,CoventGarden,LondonWC2H9HE
LibraryofCongressCataloging-in-PublicationData
Names:Jarrow,RobertA.,author.|Chatterjea,Arkadev,author.
Title:Anintroductiontoderivativesecurities,financialmarkets,andriskmanagement/
RobertJarrow(CornellUniversity),ArkadevChatterjea(IndianaUniversity).
Description:2ndedition.|NewJersey:WorldScientific,[2019]|Includesbibliographicalreferencesandindex.
Identifiers:LCCN2018022534|ISBN9781944659554
Subjects:LCSH:Derivativesecurities.|Financialinstitutions.|Capitalmarket.|Riskmanagement.
Classification:LCCHG6024.A3J37472018|DDC332.64/57--dc23
LCrecordavailableathttps://lccn.loc.gov/2018022534
BritishLibraryCataloguing-in-PublicationData
AcataloguerecordforthisbookisavailablefromtheBritishLibrary.
Copyright©2019byRobertJarrowandArkadevChatterjea
Allrightsreserved.
F o r a n y a v a i l a b l e s u p p l e m entarymaterial,pleasevisit
https://www.worldscientific.com/worldscibooks/10.1142/Y0018#t=suppl
DeskEditors:KarimahSamsudinandShreyaGopi
TypesetbydiacriTech
PrintedinSingapore
Bob: To my wife Gail for her patience and understanding.
Arka: To my wife Sudeshna for her cheerful and steadfast support, and to our daughters
Rushtri, Tvisha, and Roudra (all younger than the book!), who also cheerfully and
proudly supported my writing.
About the Authors
Robert A. Jarrow is the Ronald P. and Susan E. Lynch
Professor of Investment Management at the Samuel Curtis
JohnsonGraduateSchoolofManagement,CornellSCJohnson
CollegeofBusiness.Heisamongthemostdistinguishedfinance
scholars of his generation. Jarrow has done research in nearly
all areas of derivatives pricing. He is the co-developer of two
widely used pricing models in finance, the Heath–Jarrow–
Morton (HJM) model for pricing interest-rate derivatives and the reduced form
model for pricing securities with credit risk. He is the author of more than 200
academic publications, seven books including Option Pricing (with Andrew Rudd,
1983),ModellingFixedIncomeSecuritiesandInterestRateOptions(1996),andDerivative
Securities(withStuartTurnbull,2000),andseveraleditedvolumes.
ArkadevChatterjeaisaVisitingProfessorofFinance,Kelley
School of Business, Indiana University Bloomington. He is also
aResearchFellowatUNCChapelHillandaVisitingFellowat
CHERI,CornellUniversity.HedidhisPh.D.atCornell,where
hewasastudentofJarrow.Earlier,hewasaprofessoroffinance
at the Indian Institute of Management Calcutta. A winner of
research and teaching awards in the USA, Chatterjea has taught
derivatives at the above universities and at other institutions including CU Boulder,
theHelsinkiSchool,HongKongUST,andIIMAhmedabad.PhotobyMr.KallolNath.
Brief Contents
About the Authors VI 17 Single-Period Binomial Model 367
Preface to Second Edition XXVII
18 Multiperiod Binomial Model 392
Preface to First Edition XXXI
19 TheBlack–Scholes–MertonModel 422
20 Using the Black–Scholes–Merton
PART I Introduction
Model 462
1 Derivatives and Risk Management 2
2 Interest Rates 22
PART IV Interest Rate
3 Stocks 53 Derivatives
4 Forwards and Futures 72 21 Yields and Forward Rates 496
5 Options 92 22 Interest Rate Swaps 538
6 Arbitrage and Trading 112 23 Single-Period Binomial
Heath–Jarrow–Morton Model 558
7 Financial Engineering and Swaps 129
24 Multiperiod Binomial HJM Model 592
PART II Forwards and Futures 25 The Heath–Jarrow–Morton Libor
Model 618
8 Forwards and Futures Markets 154
26 Risk Management Models 655
9 Futures Trading 172
10 Futures Regulations 192
Appendix A:Mathematics and Statistics
11 The Cost-of-Carry Model 209 684
Glossary 693
12 The Extended Cost-of-Carry Model
229 References 704
13 Futures Hedging 256 Notation 710
Additional Sources and Websites 712
PART III Options
Books on Derivatives and Risk
14 Options Markets and Trading 288 Management 715
15 Option Trading Strategies 310 Name-Index 718
16 Option Relations 336 Subject-Index 720
This page intentionally left blank
Contents
AbouttheAuthorsVI
PrefacetoSecondEditionXXVII
PrefacetoFirstEditionXXXI
PART I Introduction
CHAPTER 1 Derivatives and Risk Management ..................... 2
1.1 Introduction 3
1.2 FinancialInnovation 5
ExpandingDerivativesMarkets 5
TwoEconomicMotives 7
1.3 TradedDerivativeSecurities 7
EXTENSION1.1: TheInfluenceofRegulations,Taxes,and
TransactionCostsonFinancialInnovation 8
DiverseViewsonDerivatives 9
ApplicationsandUsesofDerivatives 10
AQuestforBetterModels 12
1.4 Defining,Measuring,andManagingRisk 12
1.5 TheRegulator’sClassificationofRisk 12
1.6 PortfolioRiskManagement 14
1.7 CorporateFinancialRiskManagement 14
RisksThatBusinessesFace 14
NonhedgedRisks 16
RiskManagementinaBlueChipCompany 16
1.8 RiskManagementPerspectivesinThisBook 17
1.9 Summary 18
1.10 Cases 19
1.11 QuestionsandProblems 19
IX