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Practical Methods of Financial Engineering and Risk Management by Rupak Chatterjee

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CHAPTER 5

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Optimal Hedging Monte Carlo Methods

Leverage in the financial markets is one of the oldest techniques to increase one’s gains in an investment. It has also has lead to colossal losses and defaults. Leverage within an investment exists when an investor is exposed to a higher capital base than his or her original capital inlay. The margin mechanism of buying futures, as explained in Chapter 1, is a typical example of leverage. One posts margin of 5%–15% of the futures contract value but is exposed to 100% of the gains or losses of the notional amount of the futures contract. Exchanges will reduce the risk of this leverage in futures contracts ...

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