Table Of Content

Derivatives Markets ThePearsonSeriesinFinance Bekaert/Hodrick Hull InternationalFinancialManagement FundamentalsofFuturesandOptionsMarkets Berk/DeMarzo Hull CorporateFinance* Options,Futures,andOtherDerivatives Berk/DeMarzo Keown CorporateFinance:TheCore* PersonalFinance:TurningMoneyintoWealth* Berk/DeMarzo/Harford Keown/Martin/Petty FundamentalsofCorporateFinance* FoundationsofFinance:TheLogicandPracticeof FinancialManagement* Brooks FinancialManagement:CoreConcepts* Kim/Nofsinger CorporateGovernance Copeland/Weston/Shastri FinancialTheoryandCorporatePolicy Madura PersonalFinance* Dorfman/Cather IntroductiontoRiskManagementandInsurance Marthinsen RiskTakers:UsesandAbusesofFinancialDerivatives Eiteman/Stonehill/Moffett MultinationalBusinessFinance McDonald DerivativesMarkets Fabozzi BondMarkets:AnalysisandStrategies McDonald FundamentalsofDerivativesMarkets Fabozzi/Modigliani CapitalMarkets:InstitutionsandInstruments Mishkin/Eakins FinancialMarketsandInstitutions Fabozzi/Modigliani/Jones FoundationsofFinancialMarketsandInstitutions Moffett/Stonehill/Eiteman FundamentalsofMultinationalFinance Finkler FinancialManagementforPublic, Health, and Nofsinger Not-for-ProfitOrganizations PsychologyofInvesting Frasca Ormiston/Fraser PersonalFinance UnderstandingFinancialStatements Gitman/Joehnk/Smart Pennacchi FundamentalsofInvesting* TheoryofAssetPricing Gitman/Zutter Rejda PrinciplesofManagerialFinance* PrinciplesofRiskManagementandInsurance Gitman/Zutter Seiler PrinciplesofManagerialFinance—BriefEdition* PerformingFinancialStudies:AMethodological Cookbook Haugen TheInefficientStockMarket:WhatPaysOffandWhy Solnik/McLeavey GlobalInvestments Haugen TheNewFinance:Overreaction,Complexity,and Stretcher/Michael Uniqueness CasesinFinancialManagement Holden Titman/Keown/Martin ExcelModelinginCorporateFinance FinancialManagement:PrinciplesandApplications* Holden Titman/Martin ExcelModelinginInvestments Valuation: The Art and Science of Corporate InvestmentDecisions Hughes/MacDonald InternationalBanking:TextandCases Weston/Mitchel/Mulherin Takeovers,Restructuring,andCorporateGovernance *denotesMyFinanceLabtitles Logontowww.myfinancelab.comtolearnmore Derivatives Markets THIRD EDITION Robert L. McDonald Northwestern University Kellogg School of Management Boston Columbus Indianapolis NewYork SanFrancisco UpperSaddleRiver Amsterdam CapeTown Dubai London Madrid Milan Munich ParisMontreal Toronto Delhi MexicoCity SaoPaulo Sydney HongKong Seoul Singapore Taipei Tokyo EditorinChief:DonnaBattista CoverDesigner:BruceKenselaar AcquisitionsEditor:KatieRowland CreativeDirector:JayneConte EditorialProjectManager:JillKolongowski CoverArt:Shutterstock/Pokaz EditorialAssistant:ElissaSenra-Sargent MediaDirector:SusanSchoenberg DirectorofMarketing:MaggieMoylan MediaProjectManager:LisaRinaldi MarketingManager:JamiMinard SupplementsEditors:KathrynDinovo,AlisonEusden DirectorofProduction:ErinGregg Full-ServiceProjectManagement:CypressGraphics, SeniorManagingEditor:NancyFenton WindfallSoftware ProductionProjectManager:CarlaThompson Printer/Binder:EdwardsBrothers SeniorManufacturingBuyer:CarolMelville CoverPrinter:Lehigh-PhoenixColor/Hagerstown TextDesigner:GinaHagenKolenda TextFont:TimesRoman Creditsandacknowledgmentsborrowedfromothersourcesandreproduced,withpermission,inthistextbookappearon theappropriatepagewithintext. Microsoftand/oritsrespectivesuppliersmakenorepresentationsaboutthesuitabilityoftheinformationcontainedin thedocumentsandrelatedgraphicspublishedaspartoftheservicesforanypurpose.Allsuchdocumentsandrelated graphicsareprovided"asis"withoutwarrantyofanykind.Microsoftand/oritsrespectivesuppliersherebydisclaim allwarrantiesandconditionswithregardtothisinformation,includingallwarrantiesandconditionsofmerchantability, whether express, implied or statutory, fitness for a particular purpose, title and non-infringement. In no event shall Microsoftand/oritsrespectivesuppliersbeliableforanyspecial,indirectorconsequentialdamagesoranydamages whatsoeverresultingfromlossofuse,dataorprofits,whetherinanactionofcontract,negligenceorothertortiousaction, arisingoutoforinconnectionwiththeuseorperformanceofinformationavailablefromtheservices. The documents and related graphics contained herein could include technical inaccuracies or typographical errors. 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Copyright©2013,2006,2003byPearsonEducation,Inc.,publishingasPrenticeHall.Allrightsreserved.Manufactured intheUnitedStatesofAmerica.ThispublicationisprotectedbyCopyright,andpermissionshouldbeobtainedfromthe publisherpriortoanyprohibitedreproduction,storageinaretrievalsystem,ortransmissioninanyformorbyanymeans, electronic,mechanical,photocopying,recording,orlikewise.Toobtainpermission(s)tousematerialfromthiswork, pleasesubmitawrittenrequesttoPearsonEducation,Inc.,PermissionsDepartment,OneLakeStreet,UpperSaddle River,NewJersey07458,oryoumayfaxyourrequestto201-236-3290. Manyofthedesignationsbymanufacturersandsellerstodistinguishtheirproductsareclaimedastrademarks.Where thosedesignationsappearinthisbook,andthepublisherwasawareofatrademarkclaim,thedesignationshavebeen printedininitialcapsorallcaps. LibraryofCongressCataloging-in-PublicationData McDonald,RobertL.(RobertLynch) Derivativesmarkets/RobertL.McDonald.—3rded. p. cm. Includesbibliographicalreferencesandindex. ISBN-13:978-0-321-54308-0(hardcover) ISBN-10:0-321-54308-4(hardcover) 1.Derivativesecurities. I.Title. HG6024.A3M394 2013 332.64(cid:2)57—dc23 2012029875 10 9 8 7 6 5 4 3 2 1 ISBN10:0-321-54308-4 ISBN13:978-0-321-54308-0 For Irene, Claire, David, and Henry This page intentionally left blank Brief Contents Preface xxi 1 Introduction to Derivatives 1 PART ONE Insurance, Hedging, and Simple Strategies 23 2 An Introduction to Forwards and Options 25 3 Insurance, Collars, and Other Strategies 61 4 Introduction to Risk Management 89 PART TWO Forwards, Futures, and Swaps 123 5 Financial Forwards and Futures 125 6 Commodity Forwards and Futures 163 7 Interest Rate Forwards and Futures 195 8 Swaps 233 PART THREE Options 263 9 Parity and Other Option Relationships 265 10 Binomial Option Pricing: Basic Concepts 293 11 Binomial Option Pricing: Selected Topics 323 12 The Black-Scholes Formula 349 13 Market-Making and Delta-Hedging 381 14 Exotic Options: I 409 vii viii BriefContents PART FOUR Financial Engineering and Applications 435 15 Financial Engineering and Security Design 437 16 Corporate Applications 469 17 Real Options 509 PART FIVE Advanced Pricing Theory and Applications 543 18 The Lognormal Distribution 545 19 Monte Carlo Valuation 573 20 Brownian Motion and Itoˆ’s Lemma 603 21 The Black-Scholes-Merton Equation 627 22 Risk-Neutral and Martingale Pricing 649 23 Exotic Options: II 683 24 Volatility 717 25 Interest Rate and Bond Derivatives 751 26 Value at Risk 789 27 Credit Risk 815 Appendix A The Greek Alphabet 851 Appendix B Continuous Compounding 853 Appendix C Jensen’s Inequality 859 Appendix D An IntroductiontoVisual Basic for Applications 863 Glossary 883 References 897 Index 915 Contents Preface xxi PART ONE Insurance, Hedging, and Simple Strategies 23 Chapter 1 Introduction to Derivatives 1 Chapter 2 1.1 WhatIsaDerivative? 2 An Introduction to Forwards and 1.2 AnOverviewofFinancialMarkets 2 TradingofFinancialAssets 2 Options 25 MeasuresofMarketSizeandActivity 4 2.1 ForwardContracts 25 StockandBondMarkets 5 ThePayoffonaForwardContract 29 DerivativesMarkets 6 Graphing the Payoff on a Forward 1.3 TheRoleofFinancialMarkets 9 Contract 30 FinancialMarketsandtheAverages 9 Comparing a Forward and Outright Risk-Sharing 10 Purchase 30 1.4 TheUsesofDerivatives 11 Zero-CouponBondsinPayoffandProfit UsesofDerivatives 11 Diagrams 33 PerspectivesonDerivatives 13 CashSettlementVersusDelivery 34 Financial Engineering and Security CreditRisk 34 Design 14 2.2 CallOptions 35 1.5 Buying and Short-Selling Financial OptionTerminology 35 Assets 14 PayoffandProfitforaPurchasedCall Transaction Costs and the Bid-Ask Option 36 Spread 14 Payoff and Profit for a Written Call WaystoBuyorSell 15 Option 38 Short-Selling 16 2.3 PutOptions 41 TheLeaseRateofanAsset 18 Payoff and Profit for a Purchased Put RiskandScarcityinShort-Selling 18 Option 41 ChapterSummary 20 Payoff and Profit for a Written Put FurtherReading 20 Option 42 Problems 20 The“Moneyness”ofanOption 44 ix

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Risk Takers: Uses and Abuses of Financial Derivatives . Advanced Pricing Theory and Applications 543 Trading of Financial Assets 2 I produced drafts with Gnu Emacs, LaTEX, Octave, and R, extraordinarily powerful cost of production inputs, futures contracts to hedge foreign exchange risk,