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Introduction to Derivatives (KES Derivatives WorkShop)

TRANSCRIPT

  • 1. Derivatives
    Abdulla Al-Othman

2. About the Author
2
Name: Abdulla Nouri
Abdulla Abdulatif AlOthman
Biography:
Education: London School of Economics (B.Sc. First Class Honours, Mathematics & Economics); Masschussets Institute of Technology (M.Sc. Operations Research and Finance -Thesis with Distinction);Imperial College(Ph.D. Mathematics with Distinction)
Work Experience:Merrill Lynch (NY / Tokyo ):Proprietary Trader ;Ivy Software (Boston) :
CO-CEO;KMBS ( Kuwait) : Adjunct Professor of Economics and Finance.
Abdulla Alothman
3. Table of Contents

  • Day 1: The Structures

4. Basic Derivatives:Options,Forwards 5. Strategies: Yield Enhancement , Trading, Hedging 6. Exotic Derivatives: Digitals, Knockouts, Quantos 7. ComplexDerivatives: Ratchets 8. Day 2: Valuation (Technical) 9. Methodology : Trading Exercise / Market Price of Risk / Replication 10. Valuation: Model Choice=Market Price of Risk Specification 11. Models: Black and Scholes Model3
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12. Cont

  • Day 3: Applications

Trading Game (Simulator)
The Kuwaiti Dinar as a Derivative

  • The Subprime Debt Crisis

4
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13. Motivating Example
5
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14. Premium
6
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15. IQAMAS
IQAMAS
16. Payoff Structure
8
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17. Subsidized Fuel / Free Public Transportation
9
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18. 10
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19. Free* Public Transportation
11
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20. Free Electricity
12
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21. 13
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22. Free Water
14
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23. 15
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24. Free Health
16
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25. 17
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26. 18
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27. Day 1
The Basics
19
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28. BASIC DERIVATIVES
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20
29.

  • Call Options

30. Put Options 31. Forward Contracts 32. Strategies21
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33. Call Options
Are contracts, providing the holder, in return for a premium, with the right but not the obligation, to buy the underlyingasset, for a fixed price (strike price), at some future date T (expiration date).
22
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34. Payoff Diagram
c(x)=max (x-K,0)
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23
$
XT
K
35. PayoffTable
24
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36. Derivatives
Whom, us?
25
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37. Jasoom
Decides to replace his GT
26
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38. And take out a consumer loan / sign an IOU (Bond)
Yabeela Ferrari
27
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39. For 5 years at 6%
6%
28
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40. One year elapses...
Rates fall to 5% Note becomes more valuable.
i
5%
6%
29
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41. Jasoom pays off the loan..
30
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42. JasoomWith a new loan ...
31
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43. For 4 years at 5%...
5%
32
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44. Jasooms benefits (long a Call Option)
c(x)=max (P(5%,4)-P(6%,4),0)
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33
$
Pb(6%)
B1
PB(5%)
45. NBKs losses (short a Call Option)
c(x)=-max (P(5%,4)-P(6%,4),0)
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34
$
Pb(6%)
B1
PB(5%)
46. In Summary
Since all banks in Kuwait derive a large part of their revenues from consumer loans; all are, effectively, up to their eye balls in derivatives.
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35
47. Put Options
Are contracts providingthe holder , in return for a premium, with the right but not the obligation, to sell the underlyingasset for a fixed price K (strike price), at some future date T (expiration date).
36
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48. Payoff Diagram
p(x)=max (K-x,0)
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37
$
XT
K
49. PayoffTable
38
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50. Forwards
Are contracts, in which the holder has obligation to buy the underlyingasset for a fixed price K (strike price), at some future date T (expiration date).
39
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51. Payoff Diagram
f(x)=x-K
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40
$
K
XT
52. Payoff Table
41
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53. Trading Strategies
We often combine Call and Put options to create assets with interesting payoff structures.
42
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54. Long Call/Short Put
43
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55. Payoff (Synthetic Forward!!)
44
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56. Long Put/Short Put
45
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57. Payoff
46
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58. Long/Short Puts
47
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59. Payoff
48
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60. Yield Enhancement Strategies
Portfolio managers, often use options to enhance yields on their portfolios
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61. Covered Calls
50
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62. Covered Calls
450
51
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63. Hedging Strategies
Portfolio managers and firms often use options to preserve profits / hedge exposure
52
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64. Long Put
53
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65. Payoff
450
54
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66. Long Call / Short Put
K255
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67. Asset Purchase Price
Budgeted Purchase Price
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68. EXOTIC DERIVATIVES
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69. Digital Calls
c(x)=1 x > K
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$
1.00
XT
K
70. Digital Puts
p(x)=1 X < K
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59
$
1
XT
K
71. Jasoom pays his premium
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72. Asset Depreciates
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73. Jasoom is hedged!
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62
Wanassa!
74. Jasoom(long a digital put option)
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63
$
Asset State
75. Warba (short a digital put option)
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64
$
Asset State
76. Quanto Calls
c(x,y)=y*Max(x-K,0)
65
1.35
$
1.25
Y
XT
K
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77. Quanto Puts
c(x,y)=y*Max(K-x,0)
66
1.35
$
1.25
X
K
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78. Knockout Calls
The KnockOUT EFFECT
67
Barrier not hit, same as regular call
Xt
$
Barrier hit, option knocked out
Strike K
Knock Out Barrier L
time
T
K
XT
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79. Knockout Puts
The KnockOUT EFFECT
68
Xt
$
Barrier hit, option knocked out
L
Barrier not hit, same as regular put
K
time (t)
T
K
XT
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80. Knockout Digital Calls
The KnockOUT EFFECT
69
Barrier not hit, same as regular digital call
Xt
$
Barrier hit, option knocked out
Strike K
Knock Out Barrier L
time (t)
T
K
XT
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81. Knockout Digital Puts
The KnockOUT EFFECT
70
Xt
$
Barrier hit, option knocked out
L
Barrier not hit, same as regular digital put
K
time (t)
T
K
XT
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82. Ratchets (Gulf Banks Web Site)
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71
83. A Knockout Ratchet
Building Blocks
KnockOut F.X. Call Options
KnockOut F.X. Digital Call Options
Call Option Strike Price $1.5400
KnockOut Level $1.2400
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72
84. Example Cont....
EUR/USD
73
sTRUCTURE (Simplified)
Payoff Diagram
Remaining payments Knocked Out
1
2
Scenario
EURt
Time t1t2t3
$1.60
$0.01$0.01$0.01
$0.01$0.01
$0.01
$0.00
$1.56
$0.00
$0.00$0.00
$0.02
$0.02
$1.54
$0.06
$0.00
$1.24
Payoff:$0.01 $0.01$0.07
Payoff:$0.01$0.03$0.00
t1t2t3
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85. A Call /Put Ratchet
Building Blocks
(Call Option + Put Option )/2
Call Option Strike Price $1.6500
Put Option StrikePrice $1.3500
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74
86. Example 2 Cont....
EUR/USD
75
sTRUCTURE (Simplified)
Payoff Diagram
1
2
Scenario
EURt
Time t1t2t3
$1.75
$0.00$0.00$0.00
$0.04$0.04$0.04
$1.65
$0.00$0.00
$0.03$0.03
$0.05
$0.00
$1.35
$1.25
Payoff:$0.00 $0.00$0.05
Payoff:$0.04$0.07 $0.07
t1t2t3
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87. Day 2
Valuation
76
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88. At a time when
Cash was the only asset
77
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89. TheKing decided
To introduce another
78
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90. With Payoffs
Determined by the flip of afair coin
79
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91. And pricing
Left to Market Forces
80
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92. Asset Valuation (Group Exercise)
81
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93. Analysis
Risk Averse
Market
Price Range
Arbitrage Free Market
PriceRange
45o
82
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94. Market Price of Risk and Utility Theory ...
Utility of Wealth
Class MarketPriceof Risk = 5
Asset Payoff
83
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95. Market Price of Risk and Risk Ad