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Lecture 8: Derivatives II: Currency and interest rate options

Lecture 8: Derivatives II: Currency and interest rate options. Galina A Schwartz Department of Finance University of Michigan Business School. Plan of today’s lecture. Chapter 12, Levich Why options? Major players [& terminology] Option pricing: is it exact science?

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Lecture 8: Derivatives II: Currency and interest rate options

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  1. Lecture 8: Derivatives II: Currency and interest rate options Galina A Schwartz Department of Finance University of Michigan Business School

  2. Plan of today’s lecture • Chapter 12, Levich • Why options? • Major players [& terminology] • Option pricing: is it exact science? • Black-Scholes option pricing model • Its features & deficiencies • Future of options • Summary

  3. Why do we observe options? • Future contract = symmetric payoff profile • Options = nonsymmetrical payoff • Options are redundant securities • Options: -- currency -- interest rate • Players: PHLX, CME, SIMEX, etc. • Terminology: call, put, American, European

  4. Black-Scholes option pricing model • Continuous time lognormal approach • Underlying constants • [From Lecture 7] Current trends: [A very rough view] Volatility up, down and the reasons? Term structure of interest rates Currency premium? How to reduce volatility? -- Improve efficiency -- Impose regulation

  5. Summary • Option contracts: price uncertainty before maturity • Option market efficiency Is B-S model correct? Are B-S assumptions false?

  6. What is next [Lecture 10] • Monday, November 27, 2000: Derivatives III, Chapter 13, Levich • Have a Happy Thanksgiving!!!

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