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Market Risk Analysis, Volume III, Pricing, Hedging and Trading Financial Instruments

ISBN: 978-0-470-99789-5
416 pages
June 2008
Market Risk Analysis, Volume III, Pricing, Hedging and Trading Financial Instruments (0470997893) cover image


Written by leading market risk academic, Professor Carol Alexander, Pricing, Hedging and Trading Financial Instruments forms part three of the Market Risk Analysis four volume set. This book is an in-depth, practical and accessible guide to the models that are used for pricing and the strategies that are used for hedging financial instruments, and to the markets in which they trade. It provides a comprehensive, rigorous and accessible introduction to bonds, swaps, futures and forwards and options, including variance swaps, volatility indices and their futures and options, to stochastic volatility models and to modelling the implied and local volatility surfaces.

All together, the Market Risk Analysis four volume set illustrates virtually every concept or formula with a practical, numerical example or a longer, empirical case study. Across all four volumes there are approximately 300 numerical and empirical examples, 400 graphs and figures and 30 case studies many of which are contained in interactive Excel spreadsheets available from the the accompanying CD-ROM . Empirical examples and case studies specific to this volume include:

  • Duration-Convexity approximation to bond portfolios, and portfolio immunization;
  • Pricing floaters and vanilla, basis and variance swaps;
  • Coupon stripping and yield curve fitting;
  • Proxy hedging, and hedging international securities and energy futures portfolios;
  • Pricing models for European exotics, including barriers, Asians, look-backs, choosers, capped, contingent, power, quanto, compo, exchange, ‘best-of’ and spread options;
  • Libor model calibration;
  • Dynamic models for implied volatility based on principal component analysis;
  • Calibration of stochastic volatility models (Matlab code);
  • Simulations from stochastic volatility and jump models;
  • Duration, PV01 and volatility invariant cash flow mappings;
  • Delta-gamma-theta-vega mappings for options portfolios;
  • Volatility beta mapping to volatility indices.
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Table of Contents

List of Figures.

List of Tables.

List of Examples.


Preface to Volume III.

III.1 Bonds and Swaps.

III.1.1 Introduction.

III.1.2 Interest Rates.

III.1.3 Categorization of Bonds.

III.1.4 Characteristics of Bonds and Interest Rates.

III.1.5 Duration and Convexity.

III.1.6 Bonds with Semi-Annual and Floating Coupons.

III.1.7 Forward Rate Agreements and Interest Rate Swaps.

III.1.8 Present Value of Basis Point.

III.1.9 Yield Curve Fitting.

III.1.10 Convertible Bonds.

III.1.10.1 Characteristics of Convertible Bonds.

III.1.10.2 Survey of Pricing Models for Convertible Bonds.

III.1.11 Summary and Conclusions.

III.2 Futures and Forwards.

III.2.1 Introduction.

III.2.2 Characteristics of Futures and Forwards.

III.2.3 Theoretical Relationships between Spot, Forward and Futures.

III.2.4 The Basis.

III.2.5 Hedging with Forwards and Futures.

III.2.6 Hedging in Practice.

III.2.7 Using Futures for Short Term Hedging.

III.2.8 Summary and Conclusions.

III.3 Options.

III.3.1 Introduction.

III.3.2 Foundations.

III.3.3 Characteristics of Vanilla Options.

III.3.4 Hedging Options.

III.3.5 Trading Options.

III.3.6 The Black–Scholes–Merton Model.

III.3.7 The Black–Scholes–Merton Greeks.

III.3.8 Interest Rate Options.

III.3.9 Pricing Exotic Options.

III.3.10 Summary and Conclusions.

III.4 Volatility.

III.4.1 Introduction.

III.4.2 Implied Volatility.

III.4.3 Local Volatility.

III.4.4 Modelling the Dynamics of Implied Volatility.

III.4.5 Stochastic Volatility Models.

III.4.6 Scale Invariance and Hedging.

III.4.7 Trading Volatility.

III.4.8 Summary and Conclusion.

III.5 Portfolio Mapping.

III.5.1 Introduction.

III.5.2 Risk Factors and Risk Factor Sensitivities.

III.5.3 Cash Flow Mapping.

III.5.4 Applications of Cash Flow Mapping to Market Risk Management.

III.5.5 Mapping an Options Portfolio to Price Risk Factors.

III.5.6 Mapping Implied Volatility.

III.5.7 Case Study: Volatility Risk in FTSE 100 Options.

III.5.8 Summary and Conclusions.



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Author Information

Carol Alexander is a Professor of Risk Management at the ICMA Centre, University of Reading, and Chair of the Academic Advisory Council of the Professional Risk Manager’s International Association (PRMIA). She is the author of Market Models: A Guide to Financial Data Analysis(John Wiley & Sons Ltd, 2001) and has been editor and contributor of a very large number of books in finance and mathematics, including the multi-volume Professional Risk Manager’s Handbook(McGraw-Hill, 2008 and PRMIA Publications). Carol has published nearly 100 academic journal articles, book chapters and books, the majority of which focus on financial risk management and mathematical finance. Professor Alexander is one of the world’s leading authorities on market risk analysis. For further details, see www.icmacentre.rdg.ac.uk/alexander
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