This book presents details on products, models and pricing tools that are used in quantitative finance not often mentioned in academic books, attempting to provide a practical approach. It will appeal as an introductory material to both students and practitioners and may be used for financial engineering courses. It does not go in much mathematical or technical detail but it covers a wide range of products.
The first two chapters provide a basic introduction to derivatives markets, trading operations and instruments. The book is very accessible starting with very basic notions describing the types of markets, market participants, trading activities and then it moves on to describing vanilla products and several option trading strategies. Chapter 3 is an introduction to financial modeling and deals with models that are used to price and hedge instruments trying to give a practical insight into why people choose these models. Risk neutral probabilities and their use in pricing are introduced. The Black Scholes model is discussed in Chapter 4 including model assumptions, hedging strategies, greeks and model limitations. Several extensions of the models are also discussed. More complex instruments such as fixed income derivatives, caps, floors, swaps and swapoptions and their use in hedging the risk rising from the interest rates are the subject of fifth chapter. The next chapters deal with more advanced models that are able to capture the dynamics of the volatility smile (Chapter 7) inflation linked derivatives such as year on year swaps, inflation bonds and zero coupons swaps (Chapter 8) and hybrid derivatives (Chapter 9). The description of these models and instruments does not go into much mathematical depth but covers a wide range of instruments at a basic level. This makes the text a good introductory material. Chapter 10 provides an overview of several derivatives which are classified according to various criteria in an attempt to build a “product catalog” which includes some of the latest innovative financial derivatives such as callable snowballs and target redemption notes. Finally, Chapter 11 describes the pricing software developed by Pricing Partners, the home institutions of most of the authors of this book. The software is targeted at pricing instruments with a generic payoff. A generic description of the payoff without any programming development is possible and then a generic pricer can be used.