1. 1 Introduction to Derivatives

PART ONE INSURANCE, HEDGING, AND SIMPLE STRATEGIES

1. 2 An Introduction to Forwards and Options
2. 3 Insurance, Collars, and Other Strategies
3. 4 Introduction to Risk Management

PART TWO FORWARDS, FUTURES, AND SWAPS

1. 5 Financial Forwards and Futures
2. 6 Commodity Forwards and Futures
3. 7 Interest Rate Forwards and Futures
4. 8 Swaps

PART THREE OPTIONS

1. 9 Parity and Other Option Relationships
2. 10 Binomial Option Pricing: Basic Concepts
3. 11 Binomial Option Pricing: Selected Topics
4. 12 The Black-Scholes Formula
5. 13 Market-Making and Delta-Hedging
6. 14 Exotic Options: I

PART FOUR FINANCIAL ENGINEERING AND APPLICATIONS

1. 15 Financial Engineering and Security Design
2. 16 Corporate Applications
3. 17 Real Options

PART FIVE ADVANCED PRICING THEORY AND APPLICATIONS

1. 18 The Lognormal Distribution
2. 19 Monte Carlo Valuation
3. 20 Brownian Motion and Ito's Lemma
4. 21 The Black-Scholes-Merton Equation
5. 22 Risk-Neutral and Martingale Pricing
6. 23 Exotic Options: II
7. 24 Volatility
8. 25 Interest Rate and Bond Derivatives
9. 26 Value at Risk
10. 27 Credit Risk

• Concrete Applications complement the pricing discussions. Chapters on financial engineering, corporate applications, and real options all address practical problems.
• An emphasis on core economic principles helps students develop a deeper, more intuitive understanding of derivatives markets and instruments. For example, the idea that options are a form of insurance is presented at the outset.
• Integrated treatment of forward contracts and options. The initial chapters cover both forwards and options, illustrating how they are used and incorporating an extended example of hedging by gold-mining and gold-buying firms. This approach helps to unify option pricing; in particular, it makes it clear that the formula for pricing stock options is the same as the formula for pricing currency options.
• Formulas are motivated, placed in context, and explained intuitively. The goal is to help students build intuition about pricing models through their applications so they can know when a price does not make sense and why. The author provides the student with a framework for thinking about commonality among various derivative instruments.
• The Theme of Applied Computation is emphasized. Using the pre-programmed Excel spreadsheets that are packaged with the book, students can become more comfortable and fluent with pricing models and their use in spreadsheets, even before they understand the precise mathematical underpinnings.

• The third edition has been updated to include new data and examples throughout.
• Boxed material has been updated to include current topics including: James Carville on derivatives; prediction markets; Bernie Madoff; hedging and Southwest Airlines; Forbidden Futures; tanker-based arbitrage; LIBOR during the financial crisis; repo during the financial crisis; Islamic finance; the Bank Capital debate; Google and compensation options; Warren Buffet’s written put options; Hedging the PBGC’s liabilities; black swans; standardizing CDS; Government credit guarantees; structured finance and the financial crisis; Abacus and Magnetar; and more.
• New chapter 22 This new chapter emphasizes the economic underpinnings of option pricing and explains more general variations on risk-neutral pricing. A discussion of Warren Buffett’s criticism of the Black-Scholes put pricing formula is included, as well as coverage of portfolio theory, martingale pricing and implications.
• An extensive revision of the fixed income chapter including discussion of the taxonomy of fixed income models, the Hull-White model, and the LIBOR market model.
• Updated references to the financial crisis and subsequent regulatory changes throughout.
• Increased coverage of logistics of trading, including clearinghouses, and measures of market size including the OTC market.
• Updated discussion on the calculation and interpretation of hedge ratios
• Revamped introductory discussion of commodities, including the differences between commodities and financial assets, and commodities terminology.