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# Arbitrage Opportunity

Fo= So e^(R-Q)T

## Future value Compounded Continuously: Ae^(RN)

𝑚
𝑅𝑚 𝑚𝑁 𝑅𝑚
Rate conversion Continuous rate ( Rc) to compounded by “m” 𝐴𝑒 𝑅𝑐𝑁 = 𝐴(1 + ( 𝑚 ) or (simplified) 𝑒 𝑅𝑐 = (1 + ( 𝑚 ))

𝑅𝑐
𝑅𝑚
𝑅𝑐 = 𝑀𝐿𝑛(1 + ( 𝑚 )) 𝑅𝑚 = 𝑚(𝑒 𝑚 − 1)

## Zero rates: 𝐴𝑒 𝑅𝑚𝑁

𝑅2𝑇2−𝑅1𝑇1
Forward rate 𝑇2−𝑇1

Bond Pricing

## 𝑉 𝑒 −𝑅𝑇 + 𝑉𝑒 −𝑅𝑇 + (𝑉 + 𝐹)𝑒 −𝑅𝑇

V is cash-flow/ dividend payment, R is interest rate/ zero rate, T is time to maturity of payment (example 0.5 and 1 for 6
months and a year), F is Face value of bond.

Par yield
𝐶 −𝑂𝐼𝑆𝑅𝐴𝑇𝐸∗𝑇 𝑐 𝑐
𝑀
𝑒 + 𝑚 𝑒 −𝑂𝐼𝑆𝑅𝐴𝑇𝐸∗𝑇 + (𝐹𝑎𝑐𝑒𝑉𝑎𝑙𝑢𝑒 + 𝑀) 𝑒 −𝑜𝑖𝑠𝑟𝑎𝑡𝑒∗𝑇 =FACE VALUE OF BOND

(𝐵𝑜𝑛𝑑 − 𝐵𝑜𝑛𝑑𝐷)𝑀
𝐶=
𝐴

## m is number of coupon payments a year, A is PV of annuity

BOOTSTRAP METHOD
Chapter 3 Formulas
Long hedge

Cost of Asset: S2

Gain on Futures: F2-F1 (F2 is future price at purchase F1 is future price at time hedge is set up S2 is asset price at time
purchased B2 is basis at time of purchase)

## Net amount paid: S2-(F2-F1) =F1+b2

Short Hedge

Price of asset: S2

## Optimal Hedge Ratio

𝜎𝑠
ℎ ∗= 𝜌 (𝜎𝑓) Os is standard deviation of spot price, OF is the standard deviation of futures price p is
coefficient of correlation between Os and OF

## Optimal number of contracts

ℎ∗𝑄𝑎
Non adjusted for daily settlement 𝑁𝐹 =
𝑄𝑠

After tailing adjustment to allow for daily settlement of futures NF= H^Va/Vf

## Hedging using Index futures

𝑉𝑎
𝛽( ) beta is B Va is the current value of the portfolio Vf is the current value of one future (future
𝑉𝑓
price * contract size)

Changing Beta
(𝛽−𝛽∗)𝑉𝑎
or 𝑁𝑓 ∗ 𝑉𝑓 = −(𝛽𝐹 − 𝛽)𝑃 P= portfolio beta For sell (switch to (B-BF if buy)
𝑉𝑓
Chapter 5 formulas
Present value of s forward position

## Nf(Current Forward price –Purchased forward price) 𝑒 −𝑟𝑡

NF is number of forwards

The price of a future with two effective rates and (possible two currencies)
(1+𝑅𝑑)𝑇
𝐹 = (1+𝑅𝑠)^𝑇 (S) S=spot price

𝐹 = 𝑆(1 + 𝑟)𝑇

𝐹 = 𝑆𝑒 𝑅𝑇

𝐹 = (𝑆 − 𝐼)𝑒 𝑅𝑇

## Return on investment with Beta, R and Market Rate

𝑅 + 𝐵𝑒𝑡𝑎 ∗ (𝑀𝑅 − 𝑅)
Chapter 7
Valuation of a swap

## Pv of net cash flows

Time (years) Fixed cash flow Floating cash Net cash flow Discount rate Present Value
Is negative flow (positive) of net cashflow

## Discount rate is 𝑒 −𝑂𝐼𝑆𝑅𝐴𝑇𝐸∗𝑇

Floating cash flow = LIBOR*Face value*payment Frequency (payment frequency semi annual =0.5 Annual= 1 quarterly=0.25)

1
𝑅1(𝑅1 − 𝑅2)( )
𝑀2 − 𝑀1

## R1 and R2 are continuous rates

M2 and M1 are the durations of each rate (ex; 3 month and 1 month= 3-1)

## Value of the payment

𝑅𝑎𝑡𝑒𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛
(𝑃 ∗ 𝑃𝑟𝑖𝑜𝑟 𝑠𝑝𝑜𝑡 𝑟𝑎𝑡𝑒 ∗ ( ) − (𝑝 ∗ 𝑓𝑖𝑥𝑒𝑑 𝑟𝑎𝑡𝑒 ∗ ( )) 𝑒 −𝑅𝑇
12 12

Note ** T is time of payment (ex; 3 month swap option with payment every 2 months (payment in (1/12) and (3/12)