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With more than 800 copies sold throught the world, this book is a wonderful opportunity
to gain knowledge and insight in the area of FX Risk.
The original book (hardcover), edited by Jügen Hakala and Uwe Wystup, came out in 2002 as a Risk Publication.
Currently it is not printed anymore, but it can still be ordered through Uwe Wystup at a price of 195 EUR plus postage.
Please contact us (there are only 5 left in stock).
In 2008, the new softcover reprint was issued and can now be ordered directly here.
Take a look inside: Table
of Contents | Preface
| About the Authors
| Chapter One
Details
Foreign Exchange Risk
Uwe Wystup
ISBN: 1-899-33237-5
Softcover
355 pages
October 2001
Current price: €195.00
Reviews
Salih N. Neftci >>
Graduate School, CUNY, New York, and Head FAME Certificate, Switzerland
Treasures don’t come cheap…
This book is an excellent manual on tools related to four broad areas. The first
are the basic tools that are broadly applicable in all financial markets and that
form a gateway to more advanced topics. The second major category is the tools associated
in pricing, hedging and risk management of exotic options. Here there are two subcomponents;
namely, earlier exotics, such as various barriers, and their more recent relatives.
The third class is the set of techniques associated with complex volatility dynamics
and the modeling of volatility smile.
The final set of topics is made of numerical methods of modern financial engineering.
The subcomponents here are, Monte Carlo and quasi Monte Carlo methods and their
applications to pricing and hedging. Fourier transform methods in numerical analysis.
PDE methods and their applications to forward and backward Kolmogorov equations,
and, a somewhat limited discussion of tree methods.
These topics are discussed within the context of concise, FX –related pricing, hedging
and risk-management problems.
The extent of the tools provided in the book is astonishingly broad and up to date.
In fact, the only other (broadly used) major tools that are not present are perhaps
(1) A more in-depth discussion of measure change technology, (2) Characteristic
functions and Fourier transform methods other than numerical applications and (3)
The relevance of BGM type models for long term FX options. There is of course the
set of tools associated with credit analysis and derivatives that are not here,
but that is in fact appropriate. (In spite of the well known analogy between credit
default and the devaluation probability.)
Proper risk management of options books, volatility exposures and especially hedging
and risk management of exotic options portfolios will require many of the state
of the art techniques discussed in this volume. Obviously, pricing problems encountered
in dealing with these products will also be much better understood and dealt with,
by using the tools discussed here.
The audience. This book will be very useful especially for two types of potential
readers. The first are market participants with a good technical background. Experienced
traders/dealers, structurers and financial researchers, and book runners in all
instruments will find it a very useful manual to be consulted regularly. And this
is true not only in the FX sector but for interest rate, equity and commodities
as well. The only broad category that one may exclude is perhaps credit.
The second category of readers who will find this book useful and even unique in
some ways are students of Masters and beginning Ph.D. level classes in the academia.
The book will be an excellent text in technical Financial Engineering courses, or
it can be a supplement to well known textbooks such as Hull’s, in intermediate level
derivatives and risk management courses.
It must be emphasized that, although the book deals with “Foreign Exchange” as the
underlying risk, almost all the tools and motivating examples in the book apply
to interest rate and equity risk as well. In fact, Foreign Exchange is a very simple,
homogenous and liquid underlying. It does not contain any implicit options, makes
well-defined and easy-to-model “payouts” (i.e. foreign interest rates) that are
simpler to handle than dividends. Also, Foreign Exchange is not affected by corporate
actions—although Central Bank intervention could be unique in some ways-- and most
FX related instruments have relatively short expiration periods, so that the effect
of stochastic interest rates can be ignored to the first approximation.
This way FX forms an excellent medium for discussing advanced financial engineering
tools and methods. Once these tools are understood within the context of FX, they
can be extended to other more complex underlyings such as yield curve and equity.
Thus, even for those readers whose interest is ultimately in products other than
foreign exchange, the “correct” starting point to learning advanced financial engineering
methods may very well be seeing them within the context of FX markets.
An excellent example to this is the treatment and modeling of volatility smile in
the book. FX traders trade the smile routinely as vanilla products using Risk Reversals
and Butterflies. At the end, the models dealing with the volatility smile is much
easier to understand and test empirically within the Foreign Exchange context. Although
stylized facts, terminology and some of the notation used in the case of FX are
sometimes different than their counterparts in interest rates or equity, FX may
still be the “best” way of approaching modeling and calibrating issues in volatility
smile. In this sense the sequence of Chapters 2,4 and then 22 to 25 in the text
form a rather complete and up to date discussion of the volatility smile and smile
dynamics.
This is an example to another important characteristic of this text. The book is
ultimately a collection of state of the art tools and techniques to be utilized
in intermediate to advanced financial engineering tasks. Yet, this is done from
a market participant’s point of view and the reader is exposed to (1) Best market
practices, (2) Market conventions and (3) The market terminology as well. To their
credit, the authors have added several real life examples, which motivate the complex
set of tools.
A few words on the prerequisites for reading this book… It turns out that most of
the preliminary material a typical reader would need is discussed in the first 8
Chapters. However, an un-initiated reader may require a bit more background than
what is provided there. In fact, as a prerequisite it may be best if the reader
has some familiarity with most of the material in Hull’s book, and with some basics
of stochastic calculus. In particular, some earlier introduction to Ito’s Lemma,
Girsanov Theorem and Stochastic Differential Equations is something really needed.
So is some understanding of PDE methods.
In a book that attempts to discuss state of the art techniques of modern financial
engineering it is natural that there will be some missing topics. There are also
some typos, but the ones that I discovered were minor and could easily be detected
by the reader. Also given the very broad coverage of techniques and instruments,
albeit in the FX sector, advanced practitioners in each area may possibly find some
specialized aspects of the discussion on advanced techniques lacking in detail.
But, the present coverage and depth of the book is already at a surprisingly high
level.
This book will be a very useful manual for technically advanced traders, risk managers
and structurers. It is as useful for a completely different audience as well. Intermediate
and Advanced Financial Engineering classes in universities all around the world
will find it as an excellent source for learning modern tools as well as market
practices and conventions. The book also contains several real life examples and
comments. A small treasure chest... at the end.
The literature on derivatives pricing has long been dominated by academics, but
we are now starting to see full-length books written by practitioners. Examples
are Brockhaus and James and Weber. To date, results have been outstanding. Practitioners
write with the same technical sophistication as academics, but offer practical techniques
and insights that could only be gleaned from working on a trading floor. The writing
tends to be breezy and light; skips the basics and goes straight to results. For
readers who are comfortable with the occasional stochastic integral, these practitioner
books are a goldmine.
This edited collection on foreign exchange financial engineering fits the same mold.
Editors Hakala and Wystup both work for Commerzbank. They have compiled 27 outstanding
chapters by 23 authors. They have contributed significant content themselves and
have done an excellent job promoting a uniform style of writing across all chapters.
The book offers easy reading with results that flow one after another. Sources are
cited or maybe a summary is given for how a proof might be written, and then it
is off to another result or perhaps a discussion of how some instrument is really
hedged.
The book is divided into three parts. The first contains12 chapters with practical
insights on techniques used day-to-day to manage an FX derivatives book. One chapter
covers the impact of non-trading days on derivatives pricing. Another covers components
of FX volatility—smile, skew, butterfly and reversal. There are chapters on pricing
of first- and second-generation exotics, and an entire chapter focuses on quantos.
Another chapter covers put-call parity and hedging of compound options. A chapter
explains "forward" and "backward" partial differential equations. All are sophisticated
and cutting-edge.
The second part has two chapters on using and calculating the Greeks for exotics.
Much of the focus is on efficient computation based upon homogeneity and related
techniques.
The third part contains chapters on advanced pricing models and computational techniques.
There are chapters on finite differences, variance reduction, fast Fourier transforms,
quasi-Monte Carlo methods and binomial trees. For the most part these assume basic
familiarity and delve more deeply into the respective topics. Chapters on models
cover such things as local volatility surfaces, jump-diffusion models, models for
long-dated options and other instruments, Heston's volatility model, etc.
Who is this book for? First of all, it is essential reading for anyone who prices
or trades FX derivatives. Second, it is essential reading for researchers. This
one book, in a nutshell, defines the state of the art. For the same reason, I recommend
it to financial engineers working in any of the capital markets. Finally, it will
be valuable for students who understand the theory of financial engineering, but
need to learn how it is used in practice.
Foreign exchange is without any doubt the world largest financial markets with an
estimated US$ 1.2 trillion turnover in transaction per day. Its size by far outstrip
equity and bonds markets. Features such as high liquidity, low transaction cost
and readily access to leverage make foreign exchange markets a very flexible environment
for active managers. Currency markets provides a large range of strategies and instruments
to the investor and corporate that seek to extract better value from their international
risk exposures. Amongst these instruments options have taken an increasing share
of the volume transacted throughout the last ten years. At the last triennial survey
conducted by the BIS they represented an estimated daily turnover of US$ 60 Bn against
US$ 41 bn in 1995. A significant increase of more than 38 % over the past 6 years.
The main factors behind this significant increase in turnover are without any doubt
an increased sophistication of risk reporting system and better understanding of
currency issues by the international investor. However there remains much skepticism
about the use of options and the risk attached to them due to events that have shaken
financial markets and attracted much press attention in the past. However it is
also true that many of these events are often dwarfed by other corporate failures
where option risk had not any part to play. Options are arguably not always the
most cost efficient vehicles to implement active strategies in the currency markets,
however they provide the investor with a far greater degree of flexibility whilst
addressing some of the most complex hedging scenarios. They therefore should be
considered in their own right when addressing currency risk.
This book intends to give the reader a broad view on the present developments and
research of option pricing theory. The editors Jürgen Hakala and Uwe Wystup
have managed to give the reader much more than a concise review of the option literature
by compiling works of their own and also from an impressive list of contributors.
They cover practical issues that are paramount to the market practitioner.
The first section of the book (re-) introduces the reader to the basics of options
theory: Black & Scholes equation, Greeks, volatility and term structure issues.
The editors then provide ample materials on existing products, starting from the
relatively plain vanilla barrier options to more complex structures such as forward
start and ratchet options.
The second part of the book concentrates on risk management issues and takes the
reader through the computation of option price sensitivities using homogeneity properties
of financial markets. This provides a robust answer to the use of differentiations
methods that are reputably time consuming. The authors present correlation-hedging
techniques to tackle efficiently a well-known risk feature of quanto and basket
options.
The final part takes us through the most advanced pricing techniques in option pricing
theory. It looks amongst others at the use of quasi-random number generators and
Monte-Carlo approaches to value look backs and baskets options. The authors have
good credit in reviewing in high detail the main algorithms that may be used in
the sequence generation process and also elaborating on their convergence ability.
This is surely of great help for the market practitioner. They also address extensively
two very important topics: Pricing options accounting for the volatility smile implied
by market data and valuing notoriously difficult to hedge Digital options. The editors
have managed to produce a book that will be of great use to traders, financial engineers
and risk managers.
The book is written in a refreshingly fluid and accurate style, which is an achievement
in itself as applied option theory is often a difficult topic to address. The twenty-seven
chapters of this book will contribute toward a finer knowledge of this very specialized
field as well as giving some orientation in terms of future research to the reader.
This book should be an asset to the market practitioner that have or intend to have
dealing with the foreign exchange derivatives markets.
Errata
- There are many small typos in Chapter 6 "The Pricing of First Generation Exotics".
I have written a new version of the formulas, which you can see
here. Detailed typos are listed right below.
- Chapter 6 "The Pricing of First Generation Exotics": Table 6.1 contains a formula
for w, however, w is not needed for this section. The parameter m in the formula
for w is not needed either. It it is defined as SQRT(my*my+2*sigma*sigma*rd)/(sigma*sigma).
It will be used in the form of theta_/sigma in formula (6.88) for omega=0 later
on. The variable a is also not used later on.
- Chapter 6 "The Pricing of First Generation Exotics": Equations (6.12) and (6.16)
should be exchanged, i.e. (6.16) is the one for the value and (6.12) is the one
for the delta.
- Chapter 6 "The Pricing of First Generation Exotics": Page 40, Equation (6.24) end
of first line has an extra closing parenthesis ")", which should be removed. Thank
you, Jörg Kubitz, for reporting this.
- Chapter 6 "The Pricing of First Generation Exotics": Page 46, equation (6.93), gamma
of the one-touch. In the last two lines, the e+ and the e-
are divided by tau. They should be divided by (2 tau). Thank you, Sven Foulon and
Yanhong Zhao, for pointing this out. Yanhong produced a corrected formula in
pdf.
- Chapter 6 "The Pricing of First Generation Exotics": Page page 52, variables AK,
AH and ALH are defined in equations (6.142)-(6.144). The pricing formulae of the
double barrier (6.150)-(6.151) on page 53 make use of these variables and another
undefined variable AL. The mistake is made in the definition of AK in (6.142), where
the definitions of AK and AL are accidently but wrongly taken together: the right
part of the equation is the definition of AL, while for the correct definition of
AK one should replace L by K. This has been reported by Randy Brenkers and checked
by Alexander Stromilo. Thank you both. Alexander Stromilo produced a corrected version
in pdf.
- Chapter 6 "The Pricing of First Generation Exotics": Page 53 right after Equation
(6.150) the sentence should read as "Similarly we obtain for the price of the put
(\phi=-1)".
- Chapter 6 "The Pricing of First Generation Exotics": Page 53 in Equations (6.150)-(6.151)
the function N is the same as the caligraphical N defined in Table 6.1, i.e. the
standard normal cdf. Thank you, Jörg Kubitz, for reporting this.
- Chapter 7 "The Pricing of Second Generation Exotics": Page 61 Equations (7.33) and
(7.40). There is a minus sign missing in front of the discounting from the premium
payment date and the horizon date: it should be -r(T_p-t).
- Chapter 13 "Efficient Computation of Option Price Sensitivities": Equation (13.79):
A=ln(x/S_1(0))-r\tau+.... and similarly Equation (13.82): B=[ln(y/S_2(0))-r\tau+...
- Chapter 13 "Efficient Computation of Option Price Sensitivities": Equation (13.96):
in the last line it should be \phi\eta N_2 instead of \phi N_2.
- Chapter 16 "Finite Differences": Equation (16.9) should have a coefficient (1+rd*h).
In Equation (16.6) the coefficients in front of H_n^j and H_n^(j+1) should be: (-1-rd*h-e*sigma^2*h_xx)
and (-1+e'*simga^2*h_xx). In (16.8) probably +B_l(j+1) and +B_h^(j+1) respectively.
If you want to really use these, we advise you to recalculate.
- Chapter 18 "Quasi-Random Numbers and their Application to Pricing Basket and Lookback
Options": Equation (18.45): the gamma of the lookback: corrected
pdf produced by Alexander Stromilo. Thank you, Jeroen Devreese, for pointing
this out.
- Chapter 21 "Fast Fourier Method for the Valuation of Options": Figure (21.5): The
labelling of the curves FFT and Sobol should be exchanged, the best method shown
in the figure is FFT.
- Chapter 22 "Local Volatility Surfaces -- Tackling the Smile": Equation (22.11):
Seems wrong, rather use 12.6. Equation (22.12) should have a factor c(y,t) along
with the rf(t).
- Chapter 23 "Heston's Stochastic Volatility Model Applied to Foreign Exchange Options":
Table (23.1): Formula (23.17): replace d by d_j, in the argument of the Ln in the
denominator replace 1-exp(...) by 1-g_j. Formula (23.19) LHS in the arguments of
the function f replace t by tau.
There has been an explosive growth in the number of corporates, investors and financial
institutions turning to structured products to achieve cost savings, risk controls
and yield enhancements. However, the exact nature, risks and applications of these
products and solutions can be complex, and problems arise if the fundamental building
blocks and principles are not fully understood. This book explains the most popular
products and strategies with a focus on everything beyond vanilla options, dealing
with these products in a literate yet accessible manner, giving practical applications
and case studies.
A special emphasis on how the client uses the products, with interviews and descriptions
of real-life deals means that it will be possible to see how the products are applied
in day-to-day situations – the theory is translated into practice.
More than 3361 copies sold!
Take a look inside: Table
of contents and sample sections
Details
FX Options and Structured Products
Uwe Wystup
ISBN: 0-470-01145-9
Hardcover
344 pages
November 2006
Current price: €78.00
Can also be ordered at Wiley
Reviews
An excellent reference for the most widely used options and option strategies. It
gives a great overview of the products and goes further for those who are interested
in the quant side.
Errata
Please send me any errors you can find. I will use your valuable feedback for the
second edition.
- In section 1.4 on the basic strategies containing vanilla options, I give examples
of the various strategies along with profit graphs. In the tables that illustrate
the strategy with actual numbers, the currency pair is EUR-USD and the premiums
are given in EUR. However, in the profit diagrams, the premium amount is actually
in USD.
For example, in section 1.4.5 on the Strangle, from Table 1.15 a EUR 1,000,000 notional
is used and the premium given as EUR 40,000. If we focus on the call strike of 1.2000
EUR-USD, the profit diagram in Figure 1.14 shows that we break even at an spot rate
at maturity of 1.2400 EUR-USD. If this were the case, we would be buying EUR 1,000,000
@ 1.2000 for a cost of USD 1,200,000 but it would be worth EUR 1,000,000 * 1.2400
= USD 1,240,000. For this to be our breakeven, the premium we paid must have been
USD 40,000 and not EUR 40,000.
The same situation appears in the other strategies given in section 1.4. Thank you,
David Bannister for pointing this out to me.
- page 36, section 1.4.6 Butterfly: A long Butterfly is a combination of a long
straddle and a short strangle. Figure 1.15 shows the profit
of a long Butterfly. Thank you, Anupam Banerji (Equities (IT), Credit Suisse, Sydney,
Australia) for pointing out to me that the way it is written is confusing. However,
there is still a dispute in the market about the notion of long and short butterflies
(I think). I like to think of a long Butterfly as betting on market activity.
- page 51, equation (1.120), gamma of the one-touch. In the last two lines, the e+
and the e- are divided by tau. They should be divided by (2 tau). Thank
you, Sven Foulon and Yanhong Zhao, for pointing this out. Yanhong produced a corrected
formula in pdf.
- page 64, formula (1.185) for the instalment: The put-call indicators phii
have to be also in front of all the ratios inside the normal cdfs. The index i should
match the index of t. Thank you, Searle Silverman, for pointing this out to me.
- page 87, the second "Asymmetric power option" section title should be "Symmetric
power option". Thank you, Harold Cataquet, for pointing this out to me.
- Section 1.5.5 on lookback options has a better presentation in the
new version by Andreas Weber and Uwe Wystup, contributed to
Wiley's Encyclopedia of Quantitative Finance. In particular,
the spot reference in Table 1.24 is 0.9800 rather than 0.8900.
- page 11, table 1.4, the word "call" is written twice. It should be "1y EUR call
USD put". Thank you, Josua Mueller, for pointing this out to me.
- page 9, 2nd paragraph DKK instead of DKR
- page 221, second to last line: Offer Price is 26.75% rather than 36.75%
- pp 94--95 on the FX quanto drift adjustment: The notation of the angles in Figure 1.45 and the corresponding equations are not consistent. A revised version can be found in this paper.
Thank you, Daniele Moroni, Allan Mortensen, Jean-Yves Sireau, for pointing this out to me.
Solutions
The solutions are not ready, work is in progress, sorry about any inconvenience. Please do not send me
enquiries about the status of the solutions manual as these enquiries actually prevent me from
producing them. Please check this web page for information.
I will not keep it secret when I am done. Here is what I propose: if you are
interested in a particular problem and want to speed up the production of written solutions,
please make a donation to
Gandhi-Kinderhilfe,
let me know and I will work out the solution of
the problem you need and include it in the solution manual. You may wish to
be mentioned in the list of donors or stay anonymous.
Modeling Foreign Exchange Options: A Quantitative Approach
If you are interested in this book, I would kindly ask you to be patient and stay tuned to
www.mathfinance.com, where I will announce when it is complete.
Details
Modeling Foreign Exchange Options: A Quantitative Approach (The Wiley Finance Series)
Uwe Wystup
ISBN-10: 0470725478
ISBN-13: 978-0470725474
Hardcover
352 pages
Work in progress
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