Engineering New Risk Management Products

1
Engineering New Risk Management Products

• Chapter 15

2
New Products

• Multifactor swaps
• Correlation Risk producing options
• Rainbow options
• Diff swaps
• Quanto options
• Basket options

3
Combining Forwards with Swaps

• Forward swap or Delayed-start swap
• Swap payments begin at a specified later date
• Useful for planned issue of floating-rate debt

4
Combining Options with Forwards

• Allows hedge against unfavorable outcome
• Allows retention of possible benefits
• Three types of forward options are common
• Break forwards
• Range forwards
• Participating forwards

5
Break Forwards

• Modifies forward to have features of a call
• Premium is paid implicitly
• Owner can break or unwind the forward position
  at a price below the contract price

6
Break Forward Payoff Diagram
Standard Forward
Break Forward
/
1.40 1.45 1.50 1.55 1.60
7
Range Forward

• A forward contract with limited gain loss
• Same as an equity collar
• Long position in a currency put plus a short
  position in a currency call

8
Range Forward Payoff Diagram
Standard Forward
Range Forward
/
1.40 1.45 1.50 1.55 1.60
9
How is Range Forward Constructed?

• Figure 15-3
• Page 362
• What are the component parts?

10
Participating Forward

• Way to eliminate the up-front premium
• Combine short forward position with
• Long out of money call
• Short fraction of in money put
• Figure 15-4 on page 363

11
Combining Options with Swaps

• Cancelable Swaps
• Indexed-principal swap

12
Combining Options with Options

• Straddle
• Strangle
• Butterfly
• Condor

13
Restructured Swaps

• Delayed-reset swap
• In-arrears
• back-end-set swap

14
Options on Futures

• Also known as futures options

15
Options on Swaps

• Known as Swaptions

16
Options on Options

• Compound Options

17
Path-Dependent Options

• Value depends on price path followed over life of
  option
• Not simply underlying value when option is
  exercised

18
Options on Averages

• Use average prices over some period of the
  options life
• Asian options are average rate options
• Payoff is difference between the strike and the
  average spot prices observed over designated time

19
Barrier Options

• Trigger price specified
• When spot price hits trigger the option is either
• Knocked in - becomes usable
• Knocked out - disappears

20
Knock Out Options

• Common type of barrier option
• Trigger price above the spot at origination the
  option is an up-and-out
• Trigger price below the spot at origination the
  option is a down-and-out

21
Lookback Options

• Payoff is difference between highest price
  reached and exercise or zero

22
Contingent Premium Options

• Premium is set at origination but only paid if
  the option expires in-the-money
• Contingent premiums are substantially higher than
  standard premiums

23
Binary Options

• Discontinuous payoff

24
Bermuda Options

• Can be exercised at specific dates before
  expiration

25
Rainbow Options

• Determined by relative performance of two
  underlying assets

26
Differential Swaps

• Diff Swaps
• Cross-indexed swaps
• Quanto swaps

27
Basket Options

• Pays off based on a basket of assets

28
(No Transcript)