ABSTRACT
This chapter describes the basic principles of derivative security valuation. The ideas presented here can be applied to most valuation problems-from the simplest ones, involving straightforward compound interest calculations, to the most complicated, such as the valuation of exotic options. For simplicity, we will discuss a model for a securities market with finitely many final states and with a single trading period. In this model, the main definitions and results can be formulated with elementary mathematics. The key idea behind asset pricing in markets with uncertainty is the notion of a b s e n c e of arbitrageopportunities.
