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Derivatives

Derivatives. Lecture 22. Volatility. Only non-observable variable Historical volatility Predictive models ARCH (Robert Engel) GARCH Weighted Average Historical Volatility Implied Volatility VIX – Exchange traded volatility option 1993 S&P 500 Implied Volatility.

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Derivatives

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  1. Derivatives Lecture 22

  2. Volatility • Only non-observable variable • Historical volatility • Predictive models • ARCH (Robert Engel) • GARCH • Weighted Average Historical Volatility • Implied Volatility • VIX – Exchange traded volatility option • 1993 • S&P 500 Implied Volatility

  3. Implied Volatility is highest where time premium is highest…usually at the money Time Decay Days to Expiration 90 60 30 Option Price Stock Price

  4. Volatility Surface • Term Structure of Volatilities

  5. Volatility Smile Implied Volatility Asset Price Strike Price

  6. Volatility Smirk Implied Volatility Asset Price Strike Price

  7. Volatility Smirk Implied Volatility Asset Price Strike Price

  8. Mortgage Backed Securities • Ginnie Mae (Govt guaranteed) • Freddie Mac (Private) • Fannie Mae (Private) • Mortgage Conduits • Funding sources for mortgages • How mortgages and MBS are created

  9. Mortgage Backed Securities • MBS – Mortgage backed security • CMO - collateralized mort obligations • CDO – Collateralized debt obligation • REMIC - real estate mortgage investment conduits • Subprime mortgages • Private label funding

  10. Mortgage Backed Securities Stripped Mort backed Securities (SMBS) • Variable maturity tranche • Variable/Fixed rate tranche • Principal Only (PO) • Interest Only (IO)

  11. Valuing MBS Valued similar to bonds (fixed incomes) Factors • Prepayment • Weighted average coupon (WAC) • Weighted average maturity (WAM) • Required yield (YTM) • Default

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