Chapter 2
Primer on Pricing Risky Securities
2.1 Stocks and Stock Price Models
2.1.1 Underlying Assets and Derivative Securities
Let us start with a basic classification of financial instruments. First, we differentiate between underlying assets (or securities) and derivative financial contracts. A financial security is a legal claim to some future benefit. Bonds, bank deposits, common stocks, and the like are all examples of financial securities. In contrast, a general financial contract links nominally two (or more) parties. Such a contract specifies conditions under which payments or payoffs are to be made between the parties. The main example is derivative contracts whose payoff depends on the value of another financial variable such as price ...
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