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Measuring and managing market, credit and Op risk [29]

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Bullet points include: Option pay-offs (for buyer of option), strike or exercise price K, price of underlying S: Call option = max(S – K , 0) = [S – K , 0]+ = (S – K)IS – K Put-option = max(K – S , 0) = [K – S , 0]+ = (K – S)IK – S Usually pricing algorithms based on equivalent hedging strategies Which are dynamic through time Underlying factor movements transformed into non-linear overall behaviour, even if underlying factors are Brownian N.B. pay-off not the only contributor to (instantaneous) hedging portfolio Note similarities with Constant Proportional Portfolio Insurance (CPPI)

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