Book and Software Reviews

SOFTWARE REVIEW

393

Derivatives Expert 2, by Innova Financial Solutions; suggested retail price $1,195,academic pricing available. For ordering and other information visitwww.wolfram.com/products/applications/derivatives.

Derivatives Expert is software aimed at placing the complex world ofderivatives within reach ofacademics and professionals. The software is structuredas a package of routines that run on Mathematica, a high-level programminglanguage developed by Wolfram Research. The language is simple to learn andoffers an extraordinarily wide array of analytical and numerical tools to docomplicated mathematics on computer, and is therefore a natural choice to explorederivatives.

Derivatives Expert is composed of sixteen chapters. Each has two parts: awell-documented "notebook," and a matching package of software "routines."Notebooks list the available functions and illustrate their use with examples. Thisis helpful for understanding the scope of the software and the syntax of theprogramming language. Routines contain the actual program code for the functionsthat price derivatives, measure interest rate risk, and calculate hedge ratios. Bothnotebooks and routines are seamlessly integrated into Mathematica, therebysimplifying their use.

The sixteen chapters can be broken down into two categories. The firstseven can be thought ofas tools allowing the user to specify cash flows, discountingmethods, and term structures, and to calculate present values, yields to maturity, andrisk measures such as duration. The remaining nine chapters contain functions forpricing and functions for evaluating interest rate risk and hedge ratios. The readerwill find these nine chapters most helpful, covering topics such as: (1) bonds, (2)mortgage-backed securities, (3) floaters, (4) forward contracts, (5) swaps, (6)options, and (7) exotic options. Each of the last two categories is covered in twochapters.

The chapter on bonds covers three areas. For a given term structure, itprovides routines to price bonds and evaluate their duration, and for specific changesin the term structure, it provides routines to measure term-structure risk. Noprovision is made to infer terms structures, say, from market prices of bonds, orwhen measuring term structure risk to account for likely changes in the termstructure (e.g., Mann and Ramanlal (1998)). Neither is there any provision to assistmarket professionals adopt fixed-income investment strategies (e.g., Fabozzi(1996)). Thus, this chapter is useful to illustrate introductory bond-valuationconcepts to undergraduate students.

The next three chapters cover mortgage-backed securities, floaters, andforward contracts and have similar scope. All three sections would serve as excellentteaching aids to illustrate interest-rate-contingent claims to intermediate students.None of the routines, however, analyzes these securities in terms of interest rate

394 The Journal of Financial Research

trees (e.g., Hull and White (1993)), which is essential for advanced studentsundertaking a more serious study of the field or market professionals wishing toemploy trading strategies for interest-rate-contingent claims.

Derivatives Expert makes its largest contribution in the final threecategories: swaps, options, and exotic options. The section on swaps analyzesseveral types of interest rate and currency swaps. The options section incorporatesseveral option pricing models, including European, American, binomial, andcurrency options. It also enables a graphical analysis ofpartial derivatives ofpricewith respect to model parameters. Students generally are provided a visualillustration of pricing functions, but their partial derivatives are no more thancomplex mathematical expressions yielding little insight. The graphical analysisenabled by Derivatives Expert yields insights into these derivatives that mightotherwise be difficult to convey, especially with respect to implications for hedgingstrategies.

In summary, Derivatives Expert is an excellent teaching tool with thepotential to generate significant research opportunities. Itdoes not, however, providethe theoretical background necessary to understand the valuation results presented.For that, the user must refer in large part to Rubinstein and Reiner (1992) and Zhang(1998). In contrast, Hull (2000) provides an alternative that teaches thefundamentals and furnishes a (less extensive) derivatives software package in Excelspreadsheet format. In either case, incorporating practical trading strategies willmake software packages more attractive to market professionals as well.

Pradipkumar RamanlalUniversity of Central Florida

References

Fabozzi, F. J., 1996, Bond Markets, Analysis and Strategies (3d ed.) (Prentice Hall).Hull, J., 2000, Options, Futures, and Other Derivatives(4th ed.) (Prentice Hall).Hull, 1. and A. White, 1993, One-factor interest-rate models and the valuation of interest-rate derivative

securities, Journal 0/Financial and Quantitative Analysis 28, 235-54.Mann, S. V. and P. Ramanlal, 1998, Duration and convexity measures when the yield curve changes shape,

Journal ofFinancial Engineering 7, 35-56.Rubinstein, M. and E. Reiner, 1991, Breaking down the barriers, RISK 4,31-35.___ ,1992, Exotic options, Working paper, University of Cali fomi a, Berkeley.Zhang, P. G., 1998, Exotic Options: A Guide to Second Generation Options (World Scientific).