I&R M Pricing Derivatives
7 important questions on I&R M Pricing Derivatives
What is a Futures? (Futures contract)
What is meant with open interest?
What is meant with the settlement price?
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What is the difference between an American and a European option?
- American options permit exercise at any date up to T.
- European options permit exercise only on date T
How do you profit from a long futures position?
What are the steps to determine the forward price of a non-dividend-paying stock with a current price of S0?
at time 0
- Borrow S0 euros at the interest rate of rf for T years.
- Buy one stock at S0
- Short a forward contract on one stock
At time T
- Sell the stock at the forward price and receive F0
- pay back the loan
What are the steps to determine the forward exchange rate?
- borrow 1 $ at the interest rate of r$ for 1 year.
- convert 1 $ to S0 Euros, and invest at the interest rate of r for 1 year.
- Enter a forward contract to buy 1 $ at F0.
At time T,
- receive euro deposit of S0(1+r€), convert to us$ to obtain S0(1+r)/F0
- pay back the $ loan 1+r$
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