Abstract
This Chapter reviews forward contracts, futures and margin accounts. Options are then discussed in detail. Black-Scholes equation is derived and the calculation of option prices using this equation is shown for European and American options. Some popular structured products including swaps and how they might be used to enhance returns or reduce risks of diversified investment portfolios are discussed.
Derivatives are financial weapons of mass destruction.
— Warren Buffett
Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.
— Paul Samuelson
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Notes
- 1.
Parts of this Chapter is reproduced by kind permission from [46].
- 2.
For investments in U.S. Dollars the current Treasury bill rates are considered as risk-free rate of interest. T-bills are considered free of default risk because they are fully backed by the U.S. government. However, given the most recent defaults of countries like Ukraine (2016), Argentina (2014), Greece (2012), and Côte d’Ivoire (2011), the phrase “risk-free” needs to be taken with a healthy pinch of salt.
- 3.
Free on board (FOB) shipping is a trade term published by the International Chamber of Commerce (ICC), indicating which party assumes the cost of delivering goods. Some costs of FOB shipping include transportation and insurance. Cash on delivery (COD) is a type of transaction in which the recipient makes payment for a good at the time of delivery. If the purchaser does not make payment when the good is delivered, then the good is returned to the seller.
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Fischer Black, American economist (1938–1995); famous for developing the Black-Scholes formula for pricing derivative investment instruments like options together with Myron Scholes.
- 5.
Myron Scholes, Canadian-American financial economist, (1941–); famous for developing the Black-Scholes formula for pricing derivative investment instruments like options together with Robert Black.
- 6.
A not so uncommon mixture between American and European options are options which can be exercised at a fixed number of dates before the expiration date. Such options are called “Bermuda” options.
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Hacιsalihzade, S.S. (2018). Derivatives and Structured Financial Instruments. In: Control Engineering and Finance. Lecture Notes in Control and Information Sciences, vol 467. Springer, Cham. https://doi.org/10.1007/978-3-319-64492-9_9
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DOI: https://doi.org/10.1007/978-3-319-64492-9_9
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