1FinancialMarkets.ppt

1、Chapter 1 Financial Markets, 1. Markets,Nearly everyone has heard of the Hong Kong, Shanghai, and Shenzhen stock exchanges in our country. There are many other financial markets, such as the Shanghai, Henan, and Dalian future exchanges.,Important financial markets:, Stock markets, Bond markets, Curr

2、ency markets, Futures and options markets,Every item that is traded on some financial market is of one of the following types:, A basic equity, A financial derivative: the items value may be indirectly derived from the value of some other traded equity (termed the underlying equity),A stock, a bond

3、, or a unit of currency, etc.,Forwards, futures, options, etc.,The main objective of this course is to introduce the methods of computing derivative prices in terms of underlying equity prices., 2. Stocks and Their Derivatives,A stock is a certificate that shows its shareholder owns concrete number

4、of shares for some company.,The value of a companys stock reflects the views or predictions of investors about the likely dividend payments, future earnings, and resources that the company will control. Buyers and sellers of the stock exercise their views by trading shares in auction markets. That i

5、s, most of the time a stocks price is judged by what someone else is willing to pay for it on a given day.,A stock derivative is a specific contract whose value at some future date will depend entirely on the stocks future values.,The person or firm who formulates this contract and offers it for sal

6、e is termed the writer.,The person or firm who purchases the contract is termed the holder.,The stock that the contract is based on is termed the underlying equity.,2.1 Forward Stock Contracts,A forward stock contract is a contract that assures that, on some specific future date, one must buy a shar

7、e of stock for a guaranted price.,Here are the contract conditions: On a specific date, the expiration date, the holder must pay a prescribed amount of money, the exercise price, to the writer; The writer must deliver one share of stock to the holder on the expiration date.,Profit or Loss at Expirat

8、ion,The contract has a high value if todays price is much higher than the exercise price, X, and expiration is not too far away. On the other hand, if todays stock price is quite low, then perhaps it is nearly worthless.,Replicating Investment,Construct a portfolio:,One contract + amount of cash,Now

9、 the net worth of the portfolio is,On the expiration date, the portfolio gains a share of stock and pays the exercise price, but the contrived cash amount has grown into exactly the exercise price. In fact, the cash part of the investment disappears and there is no fee.,On the other hand, one usuall

10、y can sell this contract in a market even if he does not own it ( termed shorting the equity).,The investor can sell short quite large amounts of the stock today. This produce instant cash. He could use some of the cash to form the correct number of portfolio units to cover the short selling. That i

11、s, when the strike date arrives, the investor neutralizes all the short sales of stock using the replicating portfolio value as a stock value. He can pocket some cash at the beginning, regardless of future market behavior.,In fact, if Contract value + Cash amount one share of stock,First arbitrage o

12、pportunity,The investor can sell units of the portfolio short. Similar arithmetic shows that the investor can cover these short sales with cheap stock, purchased immediately after selling short. Again, some cash is earned at the beginning, regardless of future market behavior.,If Contract value + Ca

13、sh amount one share of stock,Second arbitrage opportunity,Real financial markets would not allow either of these money-making scheme to work.,Real financial markets have no arbitrage opportunity,i.e.,Example 1. Suppose we have a forward for Eli Lilly stock that will expire 40 days from now. If the e

14、xercise price is $65, and if todays stock price is $ , what is the contract price today? ( per year),Solution.,We have that,So,Exercise 1. Suppose Tom has 100 forwards for GE stock that will expire 73 days from now. If the exercise price is $100, and if todays GE stock price is $101, what is the val

15、ue of the 100 forward contracts today? ( per year),Solution.,So the value of the 100 forward contracts is,2.2 Futures Contracts,A future contract is an agreement between two parties, the buyer and the seller, to consummate a transaction on a specified date in the future. No goods or money is exchang

16、ed today.,Example 2. It is Feb. 23, 2011. The buyer and the seller enter into an agreement whereby on May 23, 2011, the seller will turn over a barrel of oil to the buyer; and, the buyer will pay the seller the previously agreed-on price of $90 for the barrel on that day. (It is a future contract),T

17、he differences between futures and forwards: Futures contract is usually traded in some futures exchange; Futures contract has standardized articles; The expiration date of futures contract is some future month but an exactly day.,There are futures contracts for stock indexes, currencies, interest r

18、ates, and commodities.,Dow, S On the expiration date, the holder of the option may pay the writer of the option the exercise price. If the writer receives the exercise price from the holder, the writer must deliver one share of stock to the holder on the expiration date.,Profit or Loss at Expiration

19、,Call payoff,d.,A European call option has the limitation that the holder may use it only when it expires.,An American call option is less restricted. The holder is allowed to convert it any time before expiration.,Example 4. (European) Suppose we hold a call for a share of General Electric (GE), an

20、d the call will expire on Oct. 10, 2011. Suppose the strike price is $88., Suppose the market price for GE is $84 on Oct. 10, 2011, then we dont exercise the call option., Suppose the market price for GE is $95 on Oct. 10, 2011, then we exercise the call option to make a profit of,2.4 Put Options,A

21、put option is a contract that assures that the holder has a right to sell a share of stock in the future for a guaranted price.,Here are the call option conditions: The buyer of the option pays the seller a fee for the option, called the premium; On the expiration date, the holder may give the write

22、r a share of stock or, equivalently, the market price of a share of stock. If the writer receives the share or its price from the holder, the writer must pay the exercise fee to the holder on the expiration date.,Profit or Loss at Expiration,Call payoff,d.,A European put option has the limitation th

23、at the holder may use it only when it expires.,An American put option is less restricted. The holder is allowed to convert it any time before expiration.,Example 5. (Protective Put) Dr. Brown owns a substantial amount of stocks of Ford. Ford stock is trading at $30 per share, and she believes that the stock price is likely to vary widely in the months ahead.,She begins a program of buying puts of approximately three months to expiration, with strike prices set at $25. She has to pay a premium of $1.2 for each put.