Lecture 8: Derivatives II: Currency and interest rate options

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Lecture 8 Derivatives II Currency and interest
rate options

• Galina A Schwartz
• Department of Finance
• University of Michigan
• Business School

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Plan of todays 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

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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

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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

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Summary

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

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What is next Lecture 10

• Monday, November 27, 2000
• Derivatives III, Chapter 13, Levich
• Have a Happy Thanksgiving!!!