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57 Basics of Derivative Pricing and Valuation (Basic concepts (Definition…
57 Basics of Derivative Pricing and Valuation
Basic concepts
Definition of pricing and valuation
Valuation
determining the payoff of the contract to the long (or short) position at some time during the life of the contract
Risk neutrality
earn only the risk-free rate
Pricing
the process of determining the no-arbitrage price
that will make the value of the contract be zero to both sides at the initiation of the contract
Carry costs
costs storage
Carry benefits
convenience yield
shorting the commodity or tight supplies
Forward pricing and valuation
No-Arbitrage Principle
Cash-and-Carry Arbitrage
Reverse Cash-and-Carry Arbitrage
Forward contracts on a dividend-paying stock
Coupon bonds
Futures pricing and valuation
Valuation of Futures Contracts
the value of a futures contract is zero at contract inception
market to market daily
the value just after marking no market is reset to zero
Swap pricing and valuation
Option pricing and valuation