Variance Swaps
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1. The document discusses variance swaps, which allow investors to bet on the realized volatility of a stock or index. 2. A variance swap pays out based on the difference between the realized variance over the contract period and the predetermined strike variance. 3. The fair value of a variance swap is the strike variance that makes the present value of the swap equal to zero. This can be calculated using stochastic calculus.
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Implied volatility is the market's forecast of a likely movement in a security's price. It is used by investors to estimate future price fluctuations and is often employed to price options contracts. Implied volatility increases in bearish markets when prices are expected to decline, and decreases in bullish markets when prices are forecast to rise. Implied volatility differs from historical volatility, which measures actual past price movements.
Derivatives
This document defines and explains various types of derivatives such as forwards, futures, options, and swaps. It discusses how derivatives derive their value from underlying assets like stocks, bonds, currencies, and commodities. Key points covered include how derivatives work, common uses of derivatives for hedging, speculation, and arbitrage, and examples of different derivative products and markets. News snippets at the end summarize the introduction of new derivative indexes in India relating to public sector companies and infrastructure stocks, as well as a new cash-futures spread product.
Volatility
Volatility refers to variation in the price of a financial instrument over time. It is quantified as the standard deviation of returns over a period. Higher volatility means price changes are less predictable and have a wider range of potential outcomes. Volatility is important for investors to consider because it affects risk, opportunities, and the likelihood of achieving financial goals under different market conditions. While volatility does not indicate direction of price movements, instruments with higher volatility will experience greater fluctuations in value over time even if their average returns are the same.
Derivatives
Derivatives derive their value from underlying assets such as stocks, commodities, currencies, and bonds. The main types of derivatives are forwards, futures, and options. Forwards involve an obligation for both parties to fulfill the contract terms at a future date. Futures are standardized contracts traded on an exchange with high liquidity. Options confer the right but not obligation to buy or sell the underlying asset at a strike price by an expiry date. Key participants in derivatives markets include speculators, hedgers, and arbitrageurs. Common derivatives strategies involve futures arbitrage, hedging, directional spreads, and volatility spreads.
DERIVATIVES LESSONS
Derivatives derive their value from underlying assets such as stocks, commodities, currencies, and bonds. The main types of derivatives are forwards, futures, and options. Forwards involve an obligation for both parties to fulfill the contract terms at a future date. Futures are standardized contracts traded on an exchange with high liquidity. Options confer the right but not obligation to buy or sell the underlying asset at a strike price by an expiry date. Key participants in derivatives markets include speculators, hedgers, and arbitrageurs. Common derivatives strategies involve futures arbitrage, hedging, and using options spreads. Greeks like delta and gamma help analyze how option prices change with movements in the underlying asset.
Interest risk and hedging
Interest-rate risk substantially affect the values of the assets and liabilities of most corporations and is often a dominant factor affecting the values of pension funds, banks and many other financial intermediaries.
Chapter 4 - Risk Management - 2nd Semester - M.Com - Bangalore University
This document discusses various concepts related to market risk, including value at risk (VaR), stress testing, and back testing. It defines VaR as a threshold loss value such that the probability of portfolio loss exceeding this value over a time horizon is a given probability, like 5%. It describes how VaR is calculated using historical, variance-covariance, and Monte Carlo simulation methods. Stress testing and back testing are also introduced as tools to assess risk under unfavorable conditions and test trading strategies on historical data.
Capital market theory
The Markowitz model generates an efficient frontier of optimal portfolios that maximize return for a given level of risk. The Capital Asset Pricing Model (CAPM) builds on this by deriving the security market line (SML) which plots the expected return of individual securities based on their beta coefficient in relation to the market portfolio. The capital market line (CML) extends the efficient frontier by including a risk-free asset, demonstrating how investors can optimize the trade-off between risk and return through borrowing and lending at the risk-free rate.
Chapter v capital market theory
The Markowitz model generates an efficient frontier of optimal portfolios based on expected return and risk. The Capital Asset Pricing Model (CAPM) further develops this by incorporating a risk-free asset, creating the Capital Market Line (CML). The CML represents equilibrium pricing relationships between expected return and risk for all efficient portfolios. According to CAPM, the expected return of any security or portfolio is equal to the risk-free rate plus a risk premium proportional to the security's systematic risk relative to the market.
Similar to Variance Swaps (20)
9.kalpesh arvind shah.subject international banking and foreign exchange risk
9.kalpesh arvind shah.subject international banking and foreign exchange risk
SECTION IV - CHAPTER 29 - Implied Volatility Basics
SECTION IV - CHAPTER 29 - Implied Volatility Basics
Chapter 4 - Risk Management - 2nd Semester - M.Com - Bangalore University
Chapter 4 - Risk Management - 2nd Semester - M.Com - Bangalore University
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Variance Swaps
- 1. Yang Han
- 7. Variance swaps are convex in Volatility
- 9. Portfolios of call options of different strikes as a function of Stock price
- 10. V is virtually independent of Stock price
- 12. A long position in a forward contract and a short position in a log contract
- 23. Relationship between monthly changes in 30-day S&P 500 variance (as measured by the VIX Index) and monthly changes in the S&P 500 Index. Vix: A high value corresponds to a more volatile market and therefore more costly options, which can be used to defray risk from this volatility by selling options
- 25. 3M S&P 500 and Nasdaq 100 Index Volatility
- 27. Correlation between Credit Risk and Equity Volatility
- 29. Thanks!