Loading in 5 sec....

Economics 434 Theory of Financial MarketsPowerPoint Presentation

Economics 434 Theory of Financial Markets

- 139 Views
- Uploaded on

Download Presentation
## PowerPoint Slideshow about ' Economics 434 Theory of Financial Markets' - beverly-leblanc

**An Image/Link below is provided (as is) to download presentation**

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.

- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript

Economics 434Theory of Financial Markets

Professor Edwin T Burton

Economics Department

The University of Virginia

The “No-Arbitrage” Principle

- Does not require “equilibrium
- Means
- Cannot make something out of nothing
- Cannot make an infinite amount out of a finite investment

Three Main Types of Derivatives

- Options
- Futures (Forwards)
- Swaps

Options

Definition

Right to buy (sell) 100 shares of stock

at a fixed price by a fixed date

Option to buy is a “call” option

Option to sell is a “put” option

Common Option Terms

- Exercise Price (or “strike” price)
- Maturity (or “expiration” date)
- Premium (or price)
- Volatility (Variance of Stock Price)

Value at Maturity

Jul 40 Calls

Expire 3rd Friday

Value

Worthless Below 40

Dollar for dollar

40

Price of the “Underlying” Stock

“Delta”

How much option price increases

for 1 point increase in stock price

Actually a “derivative” of the option price

with respect to a change in the stock price

Futures

- Different Method of Paying
- Delayed Settlement
- Like buying a house

Two Main Types of Futures(Depending Upon Settlement)

- At maturity, futures owners get something
- Either get actual commodity
- Or, get “cash equivalent”

Settlement (in the “underlying”)

- You get
- Cattle, Gold, Silver, Yen
- Whatever (?)

- Exact amount as specified in “contract” regardless of price
- Pay the original price of the futures contract

Imagine Gold

- Imagine gold at $ 1600, with risk free rate at 5 %
- 100 ounces in futures contract means $ 1600 times 100 ounces = $ 160,000
- If current gold price is $ 1600, what is the three month futures price
- Carry cost is 5 % times $ 1600 times ¼ = $ 20.00
- Answer would be $ 1,620.00
- But, what about storage cost

- If the future is $ 1626, then storage costs are $ 2.00 per three month, or $ 24 per year

Settlement in “cash”

- S&P 500 Futures
- Most Stock Index Futures

First, What is the S&P 500 Future?

- 500 Stocks
- Weighted by Market Capitalization
- Futures: Jun, Sep, Dec, Mch

Futures are “marked to market”

- Every single day
- If you can’t pay, they liquidate
- No exceptions
- Futures trade with limits
- So, you can get locked into to an infinite loss

Final Exam

- Readings
- Financial Market Theory, pp. 1-206 (which means not all of the Derivatives chapter…only up to but not including “treasury bond futures”
- This Time is Different, Chapters 5, 13, 14

- Coverage
- Fixed Income, MPT, Leverage, Options & Futures
- All classes, powerpoint slides, readings

Download Presentation

Connecting to Server..