FIN B488F

Derivatives and Risk Management

Formula Booklet

You will not be allowed to bring this booklet to the examination. An identical copy of this
handbook will be given to you together with the exam paper.

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 Formulae and Tables for Examination

Futures/Forward Pricing Equation

¿ (r −q)T
F =S e

For stock index futures

F : fair/theoretical/no-arbitrage futures price
¿

r : risk-free interest rate per annum with continuous compounding

q : dividend yield of the index (portfolio)
T : time to maturity in fraction of a year (e.g., T=0.5 for a 6-month period)

For currency forward

Formula for determining the forward price of a foreign currency against the USD

F* = S e(RUS-Rf)T

Rus (USD interest rate)

Rf (foreign currency interest rate)
S (spot exchange rate)
T time to maturity

Formula for determining the number of futures to buy or to sell to adjust the beta of the
portfolio to the target beta*

(beta* - beta) X size of portfolio in number of futures contract

Beta* =Target beta

beta =the (initial) beta of the stock portfolio before taking any long or short futures positions
beta
Size of the portfolio in number of futures contracts = value of the stock portfolio / notional
value of one futures contract

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Notional value of one futures contract = futures price X contract multiplier

The binomial option pricing model:

Su
p ƒu

S
ƒ
Sd
1-p ƒd

Risk-neutral probability of an up rt
e −d
p=
jump (Continuous compounding): u−d

Risk-neutral probability of a down jump 1− p

(Continuous compounding):

u up jump factor per period

d down jump factor per period

Delta of a call or put option (represented by f)

ƒu  f d

Su  Sd

ƒ up-state payoff (or value) of the option

u

ƒ down-state payoff (or value) of the option

d

The portfolio is risk-free if & when Su– ƒ = Sd– ƒ

u d

The value of the portfolio (short one f and take a position in S ) today is
–rT
S– f = (Su – ƒ )e
u

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 –rT
The price of the option: ƒ = S– (Su– ƒ )e
u

Investors are risk neutral if

Se rT  E ST   pSu  1  p Sd

Risk-neutral pricing for a one period binomial model

-rT
ƒ = [ p ƒ + (1 – p )ƒ ]e
u d

Risk-neutral pricing for a two period binomial model

Option value = Intrinsic value (sure thing) + speculative value

Call intrinsic value: Max [S0 – Xe-rT, 0]

Put intrinsic value: Max [Xe-rT–S0, 0]

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The Black–Scholes–Merton formula for a European call and put option is:

c  S 0 N (d1 )  X e  rT N (d 2 )
p  X e  rT N ( d 2 )  S 0 N ( d1 )
ln( S 0 / X )  (r   2 / 2)T
where d1 
 T
ln( S 0 / X )  (r   2 / 2)T
d2   d1   T
 T

is the current stock price at time t

T (expressed in a fraction of a year) is the time to maturity of the option
K is the exercise price of the option
r is the risk-free rate of interest for the period between time t and T
is the stock price volatility (standard deviation of stock returns)

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 [End of Formulae and Tables]

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