The FX derivatives trend: pricing, strategies & hedging issues
There is a market out there with a volume of $640 trillion(T). This market, or even better, this world is called over-the-counter (OTC) derivatives market. In such a huge market, it is essential to understand how derivatives work, how they are used and how they are priced. A derivative can be define...
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| Γλώσσα: | en_US |
| Δημοσίευση: |
2020
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| Θέματα: | |
| Διαθέσιμο Online: | http://hdl.handle.net/11610/19979 |
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| Περίληψη: | There is a market out there with a volume of $640 trillion(T). This market, or even better, this world is called over-the-counter (OTC) derivatives market. In such a huge market, it is essential to understand how derivatives work, how they are used and how they are priced. A derivative can be defined as a financial security whose value is derived from an underlying asset or group of assets. Although most underlying assets are stocks, bonds, commodities, interest rates and market indexes, the main underlying assets that we will focus on in this work, are going to be currencies.
The Foreign Exchange (FX) market can be split into three main product areas with increasing complexity:
I. Spot: guaranteed currency exchange occurring on the spot date.
II. Forwards: guaranteed currency exchange(s) occurring on a specified date(s) in the future.
III. Derivatives: contracts whose value is derived in some way from a reference FX rate.
A short flashback is enough to see the role of these products in the entire economy. As they have come under a great deal of criticism in the credit crisis of 2007, a brief comment of regulation is required. After representing the pricing formulas adapted to movements in volatility, the next step is to create a simulation. A business who imports or exports products is exposed to foreign exchange risk. Financial institutions offer a variety of option strategies to their corporate clients, providing thus ways to lock in prices or hedge against unfavorable movements in rates and FX—often for a limited cost. So, hedging strategies and products are going to be examined and priced. A financial institution that sells an option to a client in the OTC markets is faced with the problem of managing its risk. Therefore, the financial institution can neutralize its exposure by buying the same option that it has sold. When the option has been tailored to the needs of a client, though, hedging the exposure is far more difficult. Thankfully, the “Greeks” give a solution. |
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