Chapter 8: Derivatives

In this section

• Derivative Instrument and Derivative Market Features
  Explore the fundamentals of derivatives, their key features, and the distinctive characteristics of OTC and exchange-traded derivative markets. Understand contractual structures, margin requirements, and best practices for managing risk in these dynamic financial instruments.
• Forward Commitment and Contingent Claim Features and Instruments
  Learn the foundations of forward commitments (forwards, futures, swaps) and contingent claims (options), their features, valuations, and real-world applications in derivatives markets.
• Derivative Benefits, Risks, and Issuer and Investor Uses
  Explore the advantages of using derivatives for hedging, speculation, arbitrage, and price discovery, along with associated risks—plus how issuers and investors utilize these powerful financial instruments.
• Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives
  Explore how the Law of One Price shapes arbitrage, how replication strategies price derivatives, and why the cost of carry is central to forward and futures valuation.
• Pricing and Valuation of Forward Contracts and Underlying with Varying Maturities
  Dive into forward contracts and discover how to price and value them for assets with varying maturities. This inclusive CFA Level I guide covers cost of carry, interest rates, convenience yields, real-world examples, and best practices.
• Pricing and Valuation of Futures Contracts
  Explore the fundamentals of futures contracts, their distinguishing features from forwards, the process of marking to market, the concept of convergence, cost-of-carry pricing relationships, and how daily margin settlements affect a futures contract’s value mid-life.
• Pricing and Valuation of Interest Rates and Other Swaps
  Explore the mechanics, valuation, and real-world applications of interest rate and other swaps, including practical examples and illustrative case studies.
• Pricing and Valuation of Options
  Discover in-depth insights into option pricing, covering moneyness, intrinsic versus time value, and the essential factors affecting option valuations, along with practical applications and illustrative examples.
• Option Replication Using Put–Call Parity
  Explore how the put–call parity relationship in European options enables the replication of calls and puts, reveals arbitrage opportunities, and underpins forward-based pricing. Learn how to construct synthetic positions, spot mispricings, and build a deeper understanding of derivatives pricing.
• Valuing a Derivative Using a One-Period Binomial Model
  Learn how to use the one-period binomial model to value derivatives, explore risk-neutral probabilities, and apply real-world examples in a simplified lattice approach.