ABSTRACT
This chapter explains both how different financial instruments can be used to divide risks, and how these different financial instruments can be valued. The chapter does not intend to make you an expert in writing or valuing derivative securities, but it does intend to show you how the different instruments are constructed from the same building blocks. Once you have been introduced to these building blocks, the chapter explains the basic purposes for using the different contracts, and shows how they can be valued using the principles of pricing by arbitrage. These ideas will then help you understand the instruments’ practical uses, which are discussed at later points in the book.
