Solutions Manual For Derivatives Markets 3rd Edition
By Robert mcdonald (All Chapters, 100% Original
Verified, A+ Grade)
3rd Edition
,Table of Contents
Chapter 1 Introduction to Derivatives .................................................................................................. 1
Part One Insurance, Hedging, and Simple Strategies
Chapter 2 An Introduction to Forwards and Options ........................................................................... 8
Chapter 3 Insurance, Collars, and Other Strategies ............................................................................ 22
Chapter 4 Introduction to Risk Management ..................................................................................... 44
Part Two Forwards, Futures, and Swaps
Chapter 5 Financial Forwards and Futures......................................................................................... 69
Chapter 6 Commodity Forwards and Futures..................................................................................... 83
Chapter 7 Interest Rate Forwards and Futures ................................................................................... 92
Chapter 8 Swaps............................................................................................................................... 107
Part Three Options
Chapter 9 Parity and Other Option Relationships ............................................................................ 116
Chapter 10 Binomial Option Pricing: Basic Concepts ....................................................................... 128
Chapter 11 Binomial Option Pricing: Selected Topics....................................................................... 147
Chapter 12 The Black-Scholes Formula ............................................................................................ 170
Chapter 13 Market-Making and Delta-Hedging................................................................................. 193
Chapter 14 Exotic Options: I.............................................................................................................. 209
Part Four Financial Engineering and Applications
Chapter 15 Financial Engineering and Security Design ..................................................................... 219
Chapter 16 Corporate Applications .................................................................................................... 230
Chapter 17 Real Options .................................................................................................................... 242
Part Five Advanced Pricing Theory
Chapter 18 The Lognormal Distribution ............................................................................................ 254
Chapter 19 Monte Carlo Valuation .................................................................................................... 260
Chapter 20 Brownian Motion and Ito’s Lemma ................................................................................. 270
Chapter 21 The Black-Scholes-Merton Equation ............................................................................... 277
Chapter 22 Risk-Neutral and Martingale Pricing ............................................................................... 285
Chapter 23 Exotic Options: II ............................................................................................................ 295
.
,Iv Contents
Chapter 24 Volatility .......................................................................................................................... 307
Chapter 25 Interest Rate and Bond Derivatives ................................................................................. 328
Chapter 26 Value at Risk ................................................................................................................... 342
Chapter 27 Credit Risk ....................................................................................................................... 350
, Chapter 1
Introduction to Derivatives
Question 1.1
This problem offers different scenarios in which some companies may have an interest to hedge
their exposure to temperatures that are detrimental to their business. In answering the problem, it
is useful to ask the question: Which scenario hurts the company, and how can it protect itself?
a) A soft drink manufacturer probably sells more drinks when it is abnormally hot. She dislikes
days at which it is abnormally cold because people are likely to drink less, and her business
suffers. She will be interested in a cooling-degree-day futures contract because it will make
payments when her usual business is slow. She hedges her business risk.
b) A ski-resort operator may fear large losses if it is warmer than usual. It is detrimental to her
business if it does not snow in the beginning of the season or if the snow is melting too fast at
the end of the season. She will be interested in a heating-degree-day futures contract because
it will make payments when her usual business suffers, thus compensating the losses.
c) During the summer months, an electric utility company, such as one in the south of the United
States, will sell a lot of energy during days of excessive heat because people will use their air
conditioners, refrigerators, and fans more often, thus consuming a lot of energy and increasing
profits for the utility company. In this scenario, the utility company will have less business
during relatively colder days, and the cooling-degree-day futures offers a possibility to hedge
such risk.
Alternatively, we may think of a utility provider in the northeast during the winter months, a
region where people use many additional electric heaters. This utility provider will make more
money during unusually cold days and may be interested in a heating-degree-day contract
because that contract pays off if the primary business suffers.
d) An amusement park operator fears bad weather and cold days because people will abstain from
going to the amusement park during cold days. She will buy a cooling-degree-day future to
offset her losses from ticket sales with gains from the futures contract.
Question 1.2
A variety of counterparties are imaginable. For one, we could think about speculators who have
differences in opinion and who do not believe that we will have excessive temperature variations
during the life of the futures contracts. Thus, they are willing to take the opposing side, receiving
a payoff if the weather is stable.
Alternatively, there may be opposing hedging needs: Compare the ski-resort operator and the soft
drink manufacturer. The cooling-degree-day futures contract will pay off if the weather is
relatively mild, and we saw that the resort operator will buy the futures contract. The buyer of
1
.
By Robert mcdonald (All Chapters, 100% Original
Verified, A+ Grade)
3rd Edition
,Table of Contents
Chapter 1 Introduction to Derivatives .................................................................................................. 1
Part One Insurance, Hedging, and Simple Strategies
Chapter 2 An Introduction to Forwards and Options ........................................................................... 8
Chapter 3 Insurance, Collars, and Other Strategies ............................................................................ 22
Chapter 4 Introduction to Risk Management ..................................................................................... 44
Part Two Forwards, Futures, and Swaps
Chapter 5 Financial Forwards and Futures......................................................................................... 69
Chapter 6 Commodity Forwards and Futures..................................................................................... 83
Chapter 7 Interest Rate Forwards and Futures ................................................................................... 92
Chapter 8 Swaps............................................................................................................................... 107
Part Three Options
Chapter 9 Parity and Other Option Relationships ............................................................................ 116
Chapter 10 Binomial Option Pricing: Basic Concepts ....................................................................... 128
Chapter 11 Binomial Option Pricing: Selected Topics....................................................................... 147
Chapter 12 The Black-Scholes Formula ............................................................................................ 170
Chapter 13 Market-Making and Delta-Hedging................................................................................. 193
Chapter 14 Exotic Options: I.............................................................................................................. 209
Part Four Financial Engineering and Applications
Chapter 15 Financial Engineering and Security Design ..................................................................... 219
Chapter 16 Corporate Applications .................................................................................................... 230
Chapter 17 Real Options .................................................................................................................... 242
Part Five Advanced Pricing Theory
Chapter 18 The Lognormal Distribution ............................................................................................ 254
Chapter 19 Monte Carlo Valuation .................................................................................................... 260
Chapter 20 Brownian Motion and Ito’s Lemma ................................................................................. 270
Chapter 21 The Black-Scholes-Merton Equation ............................................................................... 277
Chapter 22 Risk-Neutral and Martingale Pricing ............................................................................... 285
Chapter 23 Exotic Options: II ............................................................................................................ 295
.
,Iv Contents
Chapter 24 Volatility .......................................................................................................................... 307
Chapter 25 Interest Rate and Bond Derivatives ................................................................................. 328
Chapter 26 Value at Risk ................................................................................................................... 342
Chapter 27 Credit Risk ....................................................................................................................... 350
, Chapter 1
Introduction to Derivatives
Question 1.1
This problem offers different scenarios in which some companies may have an interest to hedge
their exposure to temperatures that are detrimental to their business. In answering the problem, it
is useful to ask the question: Which scenario hurts the company, and how can it protect itself?
a) A soft drink manufacturer probably sells more drinks when it is abnormally hot. She dislikes
days at which it is abnormally cold because people are likely to drink less, and her business
suffers. She will be interested in a cooling-degree-day futures contract because it will make
payments when her usual business is slow. She hedges her business risk.
b) A ski-resort operator may fear large losses if it is warmer than usual. It is detrimental to her
business if it does not snow in the beginning of the season or if the snow is melting too fast at
the end of the season. She will be interested in a heating-degree-day futures contract because
it will make payments when her usual business suffers, thus compensating the losses.
c) During the summer months, an electric utility company, such as one in the south of the United
States, will sell a lot of energy during days of excessive heat because people will use their air
conditioners, refrigerators, and fans more often, thus consuming a lot of energy and increasing
profits for the utility company. In this scenario, the utility company will have less business
during relatively colder days, and the cooling-degree-day futures offers a possibility to hedge
such risk.
Alternatively, we may think of a utility provider in the northeast during the winter months, a
region where people use many additional electric heaters. This utility provider will make more
money during unusually cold days and may be interested in a heating-degree-day contract
because that contract pays off if the primary business suffers.
d) An amusement park operator fears bad weather and cold days because people will abstain from
going to the amusement park during cold days. She will buy a cooling-degree-day future to
offset her losses from ticket sales with gains from the futures contract.
Question 1.2
A variety of counterparties are imaginable. For one, we could think about speculators who have
differences in opinion and who do not believe that we will have excessive temperature variations
during the life of the futures contracts. Thus, they are willing to take the opposing side, receiving
a payoff if the weather is stable.
Alternatively, there may be opposing hedging needs: Compare the ski-resort operator and the soft
drink manufacturer. The cooling-degree-day futures contract will pay off if the weather is
relatively mild, and we saw that the resort operator will buy the futures contract. The buyer of
1
.
