The Black Model for Interest Rate Derivatives Essay

The Black Model for Interest Rate Derivatives - Essay Example Over the last two and half decades, finance has experienced tremendous and exciting developments especially with reference to derivatives markets. One of the reasons explaining the idea of tremendous and exciting developments within financial sector is the fact that both hedger and speculators within financial markets find it attractive to trade derivate specifically assets rather than trading on the assets themselves (Gupta and Subrahmanyam. 2005). Development of derivatives is considered as one of the most successful upcoming within capital markets (Brigo and Mercurio 2001). Within derivatives, there are three main traders; hedger, speculators, and arbitrageurs. Application of derivatives within financial markets helps in eliminating or reducing risk associated with the fluctuations in the prices of assets. Overview and Development of Black Model Financial markets have experienced an increase in the interest-rate contingent claims that include amongst others caps, swaptions, bond o ptions, mortgage-backed securities, as well as captions. The main problem however that is currently experienced is the development of effective and efficient instruments for valuing such contingent claims. Different models have been developed and used in an attempt to find the best and most effective one. Nonetheless, there has been indifference amongst traders on the model effective and efficient enough to help in measuring, controlling, and supervision of interest-rate risks. Hull (234) identifies Black-Scholes Model as a major innovation is pricing of various stock options. During the early 1970s, Fischer Black, Myron Scholes, and Robert Merton developed a model that can be used effectively and efficiently in pricing stock options (Hull p234). In addition, Clewlow and Strickland (2000) confirm that Black Model has been frequently used in valuing bond options due to its effectiveness and efficiency. Black Model borrows extensively from the Black-Scholes Model (Black, 1976). Actual ly the former is an extension and modification of the latter. Black Model for pricing stock options assumes that the value of an interest rate, bond price, or other variables at a given time is future follows a lognormal distribution. One of the reasons that necessitated the extension and modification of the Black-Scholes Model to Black Model is the difficulty experienced in valuing interest rate derivatives as opposed to valuing foreign exchange derivative (Hull p508). The difficulty is experienced due to a number of reasons such as complications within the behavior of individual interest rate as compared to stock prices of exchange rates (Hull p508). In addition, there has been the need to develop a model that will help in evaluating the behavior of the entire derivate including the zero-coupon yield rate. Consequently, Black Model was developed, which derives most of its assumptions from the Black-Scholes-Merton differential equation that represents the model. For instance, the m odel assumes that there are no transactional costs of taxes involved in applying the model to value stock options (Black, 1976). What’s more, the model assumes that there are no dividends obtained during the derivatives’ life coupled with facts that arbitrate opportunities are termed as riskless. In this model, another important assumption is that the rate of risk-free interest is constant and equals

MGT Assignment Example | Topics and Well Written Essays - 250 words

MGT - Assignment Example The video â€Å"Cremation Urn† presents the importance of the cremation urn in our households and the process of making the product. I derived the complex process, chemical materials, time, and equipment used in making cremation urn from the video. I also established the uses and the factors that determine the quality and size of this product. This information helps me to decide on the efficiency and quality of the cremation urn. Unfortunately, the video did not say the cost of making and the buying price of this product. Having watched the â€Å"contact lenses† video, I established the difficult process of making a single contact lens. Additionally, I learnt and understood the 14 steps involved in making a contact lens. The video also show the efficiency and uses of a contact lens. This information helped me to understand the process of making traditional contact lenses, how to store them, and the technicians involved. However, the video fails to address the computerized and modern way of making contact lenses. The video â€Å"Tetra park containers† presents the process, materials, and equipment used to make a Tetra park containers. I also derived the quality of the containers and the three layers that make the container. It also presents the technicians involved in this process. With this information, I will be able to assess the environmental impact and effectiveness of such containers. However, the video did not show how the product is eco-friendly and failed to show the process of attaching the plastic opening system. Indeed, the video also failed to present the capacity of the manufacturing machine and neglected the cost of making Tetra park containers. Finally, the â€Å"Financial services† videos showed the professionals associated with financial services and presented the operational efficiency in financial services. I also established the different types of financial services as well as the challenges in the financial sector. The video showed a