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Introduction to

Derivatives and Risk


Management
Speculative Markets

Outline
Meaning

of Speculative Markets
Meaning of Derivatives
Meaning of Financial Engineering
Types of Derivatives
Role of Derivatives
Sequence of this course

Speculative Markets
A

market that deals in derivative securities


such as options, futures, swaps, and variants
of these products
Why speculative markets?

To deal with financial risk management

What

are derivatives?

A financial instrument that derives its value from


the underlying asset on which it is written

Derivatives

are the result of financial


engineering
What is financial engineering?

Meaning of Financial
Engineering

The design, development, and the implementation of innovative


financial instruments and processes, and the formulation of
creative solutions to problems in finance
Objective is to provide custom-designed solutions to problems
that firms face in the area of financial risk management. Firms
exposure to financial risk management include interest rate risk,
currency risk, commodity price risk, security price risk, and so on.
Financial engineering is the means to implement financial
innovation

What is financial innovation?


Include not only the creation of new types of securities, but
also the development of and evolution of new financial
organizations
Financial engineering embodies many of the skills, techniques,
and processes that produce both new securities and new
financial organizations.
It is the application of advances in related technologies that
permit the diagnosis, analysis, design, production, pricing, and
customization of solutions to problems in finance

Why Financial Innovation?

Revolutionary changes in the international financial


system

Round the clock trading Tokyo-London-New York


Financial futures, swaps, mortgage-backed securities,
exchange traded options
Junk bonds
Shelf registration, electronic funds transfer and security
trading, NOW accounts, asset-based financing, LBO, etc.

Proliferation of organized trading markets in both


equity and fixed-income derivative securities during
the past two decades is unprecedented

What does financial innovation do


for the markets and participants?

Meet demands for completing market with expanded for


risk-sharing
risk-pooling,
hedging, and
intertemporal or spatial transfer of resources that are not
already available
Lower transaction costs/increase liquidity
Reduce agency costs caused by asymmetric information
Price Discovery
Greater Market Efficiency

Course Sequence

Option Markets

Futures Markets

Structure
Principles
Pricing
Strategiesbasic and advanced
Structure
Principles
Pricing
Strategies

Swaps and Other Exotic Instruments