Sebastien Bossu - An Introduction to Equity Derivatives

This English language edition published 2012
2012 Sbastien Bossu and Philippe Henrotte

Translated from the original French edition, Finance des Marchs: Techniques Quantitatives et Applications Practiques , copyright Dunod, Paris, 2008, 2nd edition.

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Library of Congress Cataloging-in-Publication Data

Bossu, Sbastien.

[Finance des marchs. English]

An introduction to equity derivatives : theory and practice / Sbastien Bossu, Philippe Henrotte.

p. cm.

Includes bibliographical references and index.

ISBN 978-1-119-96185-7 (cloth)

1. InvestmentsMathematical models. 2. Derivative securities. I. Henrotte, Philippe. II. Henrotte, Philippe.

III. Title.

HG4515.2.B6713 2012

332.6457dc23 2011051096

A catalogue record for this book is available from the British Library.

ISBN 978-1-119-96185-7 (hardback) ISBN 978-1-119-96902-0 (ebk)

ISBN 978-1-119-96903-7 (ebk) ISBN 978-1-119-96904-4 (ebk)

Original cover artwork courtesy of MGB: sites.google.com/site/artsmgb

Foreword

Today, equity derivatives are used by hundreds of thousands of people around the world not only sophisticated investors such as hedge funds, institutional investors, or investment banks, but also private investors. Their popularity is due to the wide array of applications they offer: directional strategies, risk hedging, volatility trading, structured products, to name a few.

This book will be an ideal partner for anyone discovering equity derivatives or who wants to learn more about them. The text is remarkably well structured and accessible, starting with basic concepts and slowly increasing the level of complexity. The problems and accompanying solutions add a lot of insight, and the two new chapters on volatility trading and exotic options are a must-read.

I was very pleased to be asked to write the foreword of this new edition from Sbastien Bossu under the authority of my colleague Philippe Henrotte at HEC Paris. Once again, Sbastien demonstrates his ability to combine his sleek and sharp academic style together with his first-rate practical experience. Along with his constant interaction with many market practitioners, he continues to successfully leverage off his ongoing personal research on some of the most topical pricing and modeling challenges faced by our always-evolving industry.

Olivier Bossard
Senior Managing Director
Head of Derivatives Trading EMEA at Macquarie Bank

Before joining Macquarie, Olivier Bossard has developed from scratch and led over a decade the exceptional growth of Lehman's Structured Products business in Europe. He has twenty years of experience as an exotic option trader, and has also been teaching Financial Engineering at HEC Paris Business School since 1998.

Preface

For this new edition of our 2005 title Finance and Derivatives we have considerably redrafted our text and focused our attention on equity derivatives which is our core area of expertise. There are two new chapters, numerous chapter additions, several new problems with solutions, more figures and illustrations, and more examples. As before our aim is to suit the needs of both professionals and aspiring professionals discovering the field. No prior knowledge in finance is assumed, the only required background is an undergraduate level in mathematics.

The chapters form a sequence of gradual difficulty which we grouped within three parts:

• Part I: Building Blocks (Chapters 1 to 4) covers the fundamental concepts used in quantitative finance: interest rates, the time value of money, bonds and yields, portfolio valuation, risk and return, diversification.
• Part II: First Steps in Equity Derivatives (Chapters 5 to 8) covers forward contracts, options and option strategies, the binomial model, the lognormal model, Monte-Carlo simulations, and dynamic hedging. This part only relies on discrete time concepts in order to remain widely accessible.
• Part III: Advanced Models and Techniques (Chapters 9 to 12) goes one level higher into continuous time finance and covers models for asset prices, stochastic processes and calculus, the Black-Scholes model, volatility trading, exotic derivatives, and advanced models.

Our approach was to focus on the fundamentals while covering a fair amount of practical applications. We endeavored to keep our text as concise and straightforward as possible, leaving non-essential concepts and technical proofs to problems of higher difficulty which are identified with an asterisk ( * ).

The 20072008 financial crisis highlighted the fact that derivatives were often poorly understood. We do not think that the solution is to ban them altogether: when you are in the passenger seat and have just escaped a fatal car crash after speeding, you typically don't get rid of the car. Rather, we believe that more information and training is needed in the field (along with better drivers), and we hope that this new edition will prove useful and insightful to a large audience.

Disclaimer

This is a book about finance intended for professionals and future professionals. We are not trying to sell you any security, or give you any investment advice. The views expressed here are solely ours and do not necessarily reflect those of any entity directly or indirectly related to us. We took great care in proof-reading this book, but we disclaim any responsibility for any remaining errors and any use to which the contents of this book are put.

Addendum: A Path to Economic Renaissance

The following opinion piece only reflects the personal views of the author and does not engage any other contributor to this book.