ch01colhullfundamentals4thed

8/13/2019 Ch01ColHullFundamentals4thEd

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1.1

Fundamentals of Futures and Options Markets, 4th edition 2001 by John C. Hull


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1.2

The Nature of Derivatives

A derivative is an instrument whose

value depends on the values of othermore basic underlying variables



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1.3

Examples of Derivatives

Forward Contracts

Swaps Options



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1.4

Ways Derivatives are Used

To hedge risks

To speculate (take a view on thefuture direction of the market)

To lock in an arbitrage profit To change the nature of a liability

To chan e the nature of an investment


without incurring the costs of sellingone portfolio and buying another


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1.5

Futures Contracts

A futures contract is an agreement tobuy or sell an asset at a certain time inthe future for a certain price

By contrast in a spot contract there isan agreement to buy or sell the asset


period of time)


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1.6

Exchanges Trading Futures

Chicago Mercantile Exchange

LIFFE (London) Eurex (Europe)


,

TIFFE (Tokyo) and many more (see list at end of book)


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1.7

Futures Price

contract is the price at which you agree

to buy or sell It is determined by supply and demand

in the same way as a spot price



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1.8

Electronic Trading

been traded using the open outcry

system where traders physically meeton the floor of the exchange

Increasingly this is being replaced by


electronic trading where a computermatches buyers and sellers


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1.9

Examples of Futures Contracts

A reement to:

buy 100 oz. of gold @ US$400/oz.in December (COMEX)

sell 62,500 @ 1.5000 US$/ inMarch (CME)


sell 1,000 bbl. of oil @ US$20/bbl.in April (NYMEX)


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1.10

Terminology

The art that has a reedto buy has a long position

The party that has agreedto sell has a short position



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1.11

Example

January: an investor enters into along futures contract on COMEX to

buy 100 oz of gold @ $300 in April

April: the price of gold $315 per oz


What is the investors profit?


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1.12

Over-the Counter Markets

-important alternative to exchanges

It is a telephone and computer-linkednetwork of dealers who do notphysically meet


institutions, corporate treasurers, andfund managers


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1.13

Forward Contracts

except that they trade in the over-the-

counter market Forward contracts are popular on

currencies and interest rates



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1.14

Foreign Exchange Quotes for

GBP(See page 4)Bid Offer

Spot 1.5118 1.5122

1-month forward 1.5127 1.5132


- . .

6-month forward 1.5172 1.5178


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1.15

Options

certain asset by a certain date for a

certain price (the strike price) A put option is an option to sell a


certain price (the strike price)


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1.16

American vs European Options

at any time during its life

A European option can be exercisedonly at maturity



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1.17

Cisco Options (May 8, 2000;

Stock Price=62.75);See page 5

StrikePrice

JulyCall

OctCall

JulyPut

OctPut

50 16.87 18.87 2.69 4.62

65 7.00 10.87 8.25 10.62


80 2.00 5.00 17.50 19.50


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1.18

Exchanges Trading Options

American Stock Exchange

Philadelphia Stock Exchange Pacific Exchange


Eurex (Europe) and many more (see list at end of book)

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1.19

Options vs Futures/Forwards

holder the obligation to buy or sell at a

certain price An option gives the holder the right to

buy or sell at a certain price


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1.20

Types of Traders

Hedgers

Speculators

Arbitrageurs

Some of the large trading losses in


derivatives occurred because individuals

who had a mandate to hedge risks switchedto being speculators (See Chapter 21)

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1.21

Hedging Examples(pages 7-9)

A US company will pay 10 million forim orts from Britain in 3 months anddecides to hedge using a long positionin a forward contract

An investor owns 1,000 Microsoftshares currently worth $73 per share. Atwo-month ut with a strike rice of 63


costs $2.50. The investor decides tohedge by buying 10 contracts

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1.22

Speculation Example(pages 10-11)

An investor with $4,000 to invest feelsthat Amazon.coms stock price will

increase over the next 2 months. Thecurrent stock price is $40 and the price

-


45 is $2 What are the alternative strategies?

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1.23

Arbitrage Example(pages 12-13)

A stock price is quoted as 100 inLondon and $172 in New York

The current exchange rate is 1.7500

What is the arbitrage opportunity?


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1.24

1. Gold: An Arbitrage

Opportunity? Suppose that:

The spot price of gold is US$390

The quoted 1-year futures price of goldis US$425


-

annum Is there an arbitrage opportunity?


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1.27

1. Oil: An Arbitrage

Opportunity?Suppose that: The spot price of oil is US$19

The quoted 1-year futures price of

oil is US$25 The 1-year US$ interest rate is 5%

per annum


The storage costs of oil are 2% per


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1.28

2. Oil: Another Arbitrage

Opportunity? Suppose that: The spot price of oil is US$19

The quoted 1-year futures price of

oil is US$16 The 1-year US$ interest rate is 5%

per annum


e s orage cos s o o are per


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