Consumption vs Investment Assets Investment assets are assets held by significant numbers of people purely for investment purposes (Examples: gold, silver) Consumption assets are assets held primarily for consumption(Examples: copper, oil)

The nature of derivatives a derivative is an instrument whose value depends on the values of other more basic underlying variables Options, Futures, and Other Derivatives, 5th edition C 2002 by John C. Hull

Types of Rates Treasury rates LIBOR rates Repo rates Options, Futures, and Other Derivatives, 5th edition@ 2002 by John C. Hull

Three Alternative strategies Take a position in the option and the underlying Take a position in 2 or more options of the same type(a spread Combination: Take a position in a mixture of calls puts(A combination)

The Stock Price Assumption Consider a stock whose price is s In a short period of time of length 8t, the return on the stock is normally distributed

A bank has sold for $300,000 a European call option on 100,000 shares of a nondividend paying stock S=49,K=50,=5%,=20% T=20 weeks,μ=13%

Categorization of Stochastic Processes Discrete time; discrete variable Discrete time; continuous variable Continuous time; discrete variable Continuous time; continuous variable Options, Futures, and Other Derivatives,5 th edition2002 by John.hull

A Simple Binomial model A stock price is currently $20 In three months it will be either $22 or

American vs European options An American option is worth at least as much as the corresponding European option

Types of options A call is an option to buy A put is an option to sell A European option can be exercised only at the end of its life An American option can be exercised at any time