Foreign-Exchange-Risk-Pricing-and-Hedging-Exotic-Instruments

Foreign Exchange Risk: Pricing and Hedging Exotic Instruments

Foreign Exchange Risk: Pricing and Hedging Exotic Instruments
Delia Pirnog1
Master of Advanced Studies in Finance Eidgen¨ssische Technische Hochschule / Universit¨t Z¨rich, o a u Schweiz Abstract
This project discusses exotic instruments used in the Foreign Exchange(FX) markets. An overview of the most popular exotic derivatives is presented, followed by the pricing alternatives of these securities. Hedging methods using static replication for some classes of exotic options are afterward discussed. Finally, risk management control of an active FX portfolio is studied.

keywords: FX market, Exotic options, Option pricing, Barrier Options, Digital Options, Static Hedging, Dynamic Hedging.
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Email: delia [e-mail]

Acknowledgment This paper was sponsored by UBS as part of an internship at Market Risk Control department from UBS Opfikon. I would like to thank Professor Markus Leippold for his assistance throughout the project and for allowing me to deal with this topic. I am grateful to Roberto Frassanito, Federica Mazzucato, Nicolas Curin and the whole team at UBS-Market Risk Control for their availability, patience and for the help they provided.

Contents
1 FX Exotic Options - an overview 1.1 Introduction . . . . . . . . . . . . . . . . 1.2 Barrier options . . . . . . . . . . . . . . 1.2.1 Barrier Options Market . . . . . 1.2.2 Pricing Barrier Options . . . . . . 1.3 Digital Options . . . . . . . . . . . . . . 1.3.1 Payoff . . . . . . . . . . . . . . . 1.3.2 Pricing . . . . . . . . . . . . . . . 1.4 One-touch digital options . . . . . . . . . 1.4.1 Payoff . . . . . . . . . . . . . . . 1.4.2 Pricing one-touch digital options 1.5 Double Barrier Options . . . . . . . . . . 1.6 Other Exotic Options . . . . . . . . . . . 7 7 8 8 9 15 15 15 16 16 17 18 19 21 21 24 27 30 31 34 36

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