This book contains solutions to the questions and problems that appear at the ends of chapter in the sixth edition. The questions and problems have been designed to help readers study on their own and test their understanding of the material. They range from quick checks on whether a key point is understood to much more challenging applications of analytical techniques. At the beginning of each chapter of the Solutions Manual and Study Guide there have been included a summary of the main points in the chapter and suggested ways readers should approach studying the material in the chapter. Students should find these summaries useful both when they first cover the material in the chapter and when they are studying for exams.
This book has been written for undergraduate and graduate elective courses offered by business, economics, and other faculties. Many practitioners who want to acquire a working knowledge of futures and options markets will also find the book useful.
I was persuaded to write this book by colleagues who liked my other book Options, Futures, and Other Derivatives, but found the material a little too advanced for their students. Fundamentals of Futures and Options Markets (formerly Introduction to Futures and Options Markets) covers some of the same ground as Options, Futures, and Other Derivatives—but in a way that readers who have had limited training in mathematics will find easier to understand. One important difference between this book and my other one is that there is no calculus in this book.
The text can be used in a number of different ways. Instructors who like to focus on one- and two-step binomial trees when valuing options may wish to cover only the first 10 chapters. Instructors who feel that swaps are adequately covered by other courses can choose to omit Chapter 6. There are many different ways in which Chapters 11 to 21 can be used. Instructors who feel that the material in Chapters 14, 16, 17, or 18 is too specialized can skip one or more of these chapters. Some instructors may choose to devote relatively more time to futures and swaps markets (Chapters 1 and 6); others may choose to structure their course mostly around options markets (Chapters 7 to 21). The three new Chapters (19 to 21) contain very little mathematics and do not rely heavily on earlier material. I find they work well when used in the last two tothree weeks of a course regardless of what, is covered earlier.
Chapter 1 provides an introduction to futures and options markets and outlines the different ways in which they can be used. Chapter 2 describes the mechanics of how futures and forward contracts work. Chapter 3 shows how forward and futures prices can be determined in a variety of different situations by using pure arbitrage arguments. Chapter 4 discusses how futures contracts can be used for hedging. Chapter 5 deals with interest rate markets. Chapter 6 covers swaps. Chapter 7 describes the mechanics of how options markets work. Chapter 8 develops some relationships that must hold in options markets if there are to be no arbitrage opportunities. Chapter 9 outlines a number of different trading strategies involving options. Chapter 10 shows how options can be priced using one- and two-step binomial trees. Chapter 1 I discusses the pricing of stock options using the Black-Scholes model. Chapter 12 extends the ideas in Chapter 11 to cover options on stock indices and currencies. Chapter 13 extends the ideas in Chapter 11 to futures options. Chapter 14 discusses volatility smiles. Chapter 15 provides a detailed treatment of hedge parameters such as delta, gamma, and vega. It also discusses portfolio insurance. Chapter 16 explains how to calculate and use the value-at-risk measure. Chapter 17 covers the use of multistep binomial trees to value American options. Chapter 18 focuses on interest rate options. Chapter 19 covers exotic options, mortgage-backed securities, and nonstandard swaps. Chapter 20 covers some relatively new derivative products: credit derivatives, weather derivatives, energy derivatives, and insurance derivatives. Chapter 21 describes some well-publicized derivatives disasters and reviews the lessons we can learn from them.
At the end of each chapter (except the last one) there are seven quiz questions that students can use to provide a quick test of their understanding of the key concepts. The answers to these are at the end of the book.
The major changes in this edition include:
Three new chapters have been added (Chapters 19, 20, and 21). These are entitled Exotic Options and Other Nonstandard Products; Credit,Weather, Energy, and Insurance Derivatives; and Derivative Mishaps and What We Can Learn from Them. In my experience, students really enjoy covering the material in these chapters.
Chapter 5 on Interest Rate Markets has been rewritten to make it more relevant and easier to understand.
Chapter 14 on Volatility Smiles has been rewritten so that it accurately reflects current trading practices. This chapter now appears earlier in the book than the corresponding chapter in the third edition.
Chapter 16 on Value at Risk has been rewritten to reflect developments in this area.
The notation has been improved. For example, S0 and F0 are now used to refer to the spot price and the forward/futures price today.
Many new problems have been added.
Material has been updated throughout the book and the presentation improved.
New Excel-based software, DerivaGem, is included with the book. This software is a great improvement over that included with previous editions. It has been carefully designed to complement the material in the text. Users can calculate options prices, imply volatilities, and calculate Greek letters for European options, American options, exotic options, and interest rate options. The software can be used to display binomial trees (see, for example, Figures 17.3 to 17.9) and to produce many different charts showing the impact of different variables on either option prices or the Greek letters.
The software is described more fully at the end of the book. Updates to the software can be downloaded from my Web site http://www.rotman.utoronto.ca/~hull
Several hundred PowerPoint slides can be downloaded from my Web site. They use only standard fonts. Instructors adopting the book are welcome to adapt the slides to meet their own needs.
Answers to Questions
Solutions to all end-of-chapter problems (except quiz questions) were available only in the Instructors Manual for the first three editions of this book. Over the years, many people have asked me to make the solutions more generally available. I have hesitated to do this because it would prevent instructors from using the problems as assignment questions.
In this edition I have dealt with this issue by dividing the end-of-chapter problems into two groups: "Questions and Problems" and "Assignment Questions." There are over 200 Questions and Problems, and answers to these are in the Solutions Manual for Fundamentals of Futures and Options Markets, which is published by Prentice Hall. There are about 70 Assignment Questions. Solutions to these are available only in the Instructors Manual.
Many people have played a part in the production of this book. Academics, students, and practitioners who have made excellent and useful suggestions include Farhang Aslani, Emilio Barone, Giovanni Barone-Adesi, George Blazenko, Laurence Booth, Phelim Boyle, Peter Carr, Don Chance, J.-P. Chateau, Brian Donaldson, Jerome Duncan, Steinar Ekern, Robert Eldridge, David Fowler, Louis Gagnon, Mark Garman, Dajiang Guo, Bernie Hildebrandt, Jim Hilliard, Basil Kalymon, Patrick Kearney, Cheng-kun Kuo, Elizabeth Maynes, Izzy Nelken, Paul Potvin, Richard Rendleman, Gordon Roberts, Edward Robbins, Chris Robinson, John Rumsey, Klaus Schurger, Eduardo Schwartz, Michael Selby, Piet Sercu, Yochanan Shachmurove, Bill Shao, Stuart Turnbull, Yisong Tian, Ton Vorst, George Wang, Zhanshun Wei, Bob Whaley, Alan White, Qunfeng Yang, and Jozef Zemek. Huafeng (Florence) Wu provided excellent research assistance.
I would particularly like to thank Alan White. Alan is a colleague at the University of Toronto with whom I have been carrying out joint research in options and futures for the last 18 years. We have spent many hours discussing different issues concerning options and futures markets. Many of the new ideas in this book, and many of the new ways used to explain old ideas, are as much Alan's as mine.
Special thanks are due to many people at Prentice Hall for their enthusiasm, advice, and encouragement. I would particularly like to thank Mickey Cox (my editor), P. J. Boardman (the editor-in-chief), and Richard DeLorenzo (the production editor). I am also grateful to Scott Barr, Leah Jewell, Paul Donnelly, and Maureen Riopelle, who at different times have played key roles in the development of this book. I welcome comments on the book from readers. My e-mail address is firstname.lastname@example.org