BT 325



QF 201

Principles of Quantitative Finance

Fall 2009

Instructor: Dr. Jonathan Kaufman Office: Babbio (4th floor)

Email: jonathan.kaufman@stevens.edu Office Hours: 1:45-3:00 Phone: 201-216-8937 T/Th and by appointment

Required Reading: Sections as assigned of:

Wall Street Journal Subscription

Financial Times Subscription

Class Notes

One preapproved nonfiction book relating to QF

Selected articles or papers posted on WordPress

Supplemental Reading for Students Transferring to QF Program

Selected portions of:

Brealey and Myers, Principles of Corporate Finance, 6th edition, 2008

Kimmel, Weygandt and Kieso, Accounting, 3rd edition, 2008.

Learning Goals:

Quantitative Finance (QF), the application of quantitative methods to finance, has become an important tool in the analysis and execution of trades in global financial markets. An understanding of QF is also required for internal corporate risk management, risk evaluation by rating agencies and to support global, national and local regulatory frameworks. The goal of this course is to provide students with the conceptual building blocks of and core competence in the design and implementation of some basic methods for quantitative financial modeling and risk evaluation. Many of the variables that are used in QF rely on accounting data, such as earnings per share or published or calculated cash flows such as EBITDA. In addition many of the parameters employed by QF models, such as measures of risk aversion, seniority in the corporate structure, time value and uncertainty are derived from economic and financial models. Because some Sophomore students transferring into the QF program will have no formal background in these areas ( roughly half are anticipated to be transferring Computer Science majors), a brief review of some very basic legal, accounting and corporate finance concepts that support the use of QF will be necessary. Those students may also find reference to the supplemental reading useful. The review of these concepts will be limited to the bare essentials necessary to support the QF concepts and models, will be presented in a manner consistent with the existing courses in economics, corporate finance and accounting in the BT and CF spines, and in no way will serve as a substitute for the more detailed and thorough treatment of these topics in those courses.

Students will be assigned to three or four QF project teams of three to four students each. The purpose of the project teams will be to allow students to employ some or all of the building blocks learned to design a virtual hedge fund. Hopefully, this team approach will also emphasize the real world value of teamwork and task delegation and coordination in modeling financial markets and in managing risk in the corporate environment. Each team will make three presentations on i) preliminary design concept, ii) actual design and implementation and iii) necessary modifications and the performance of their funds. There will also be short quizzes each class on current news or assigned articles relevant to the lectures or to QF generally.

Grading:

Final Grades will be tentatively determined on the following basis:

Exam #1 30%

Exam #2 30%

Projects, Class participation,

Quizzes and homework 40%

Prerequisites:

In the current year there are no prerequisites other than a basic knowledge of Calculus. A working knowledge of basic statistics and probability theory would also be useful. As this will be the second year “spine course” in QF, in the future most students will have taken QF 101, and basic accounting and corporate finance and economics - these concepts are essential building blocks that provide the data for variables and the parameters for modeling in and understanding QF. Since this year roughly half the students will take these courses concurrently with corporate finance and accounting courses while the other half or more will have no background in these areas, a summary treatment of these topics must be provided. However, every effort will be made to reinforce concepts from other courses uniformly and avoid unnecessary duplication.

Pedagogy

This course is developed for people who will be using quantitative finance techniques to assist or manage end users such as hedge funds, rating agencies, financial regulators, or internal risk management systems, or for those who will need to understand these tools in their interactions with such institutions. By the end of this course, all of the students should have mastered the fundamental building blocks of QF, and should be able to design, implement and test a simple QF model for valuation of corporate securities and other assets such as simple derivatives. Also, students should be able to understand simple risk models and evaluate their strengths and weaknesses in a critical fashion. Finally, all students will have the necessary background to move forward to master more complicated QF concepts to be taught as they proceed in the program. I anticipate that the virtual hedge funds developed in this course will be modified and fine tuned in future courses.

Reading Assignments:

Students will be responsible for keeping up with current developments in the financial world, especially as they relate to the world of quantitative finance and to the concepts covered in class. Accordingly, students will be responsible for subscribing to and reading the Wall Street Journal (WSJ) and the Financial Times (FT) each day. I will also occasionally post on WordPress additional required reading such as op-ed pieces, articles from the Economist, etc. In addition, each student project team will be required to read and give a short class presentation on a relevant book such as Taleb’s “The Black Swan ,” Loewenstein’s “When Genius Failed,” or H. Frank Knight’s “Risk and Uncertainty,” or an approved alternative. All presentations are expected to run 10 to 15 minutes with a five to ten minute Q&A period to follow. Essential material includes lecture material, student class presentations, current news relevant to QF from the WSJ and FT and other articles as assigned and posted on WordPress. Essential material will be quizzed on an ongoing basis in each class as well as on the midterm and final exams, so attendance at each class will be necessary.

I also plan to cover some topics relating to accounting and finance corresponding to selected chapters from each of the two supplemental textbooks and only to the extent necessary to grasp the fundamental building blocks relied upon for variables and parameters used in QF. Students transferring to the QF program in the sophomore year and with no background in these topics may find that the supplemental reading helps to reinforce the lectures on these topics.

Projects:

Students will form teams of 3 or 4 students responsible for a team project .Each team will design a quantitative investment methodology, and use that methodology to construct a virtual portfolio on StockTrak that may include any instrument that is publicly traded in any market anywhere in the world so long as daily price information is available. Each team will make three class short presentations of ten to fifteen minutes at regularly scheduled intervals throughout the semester, followed by several minutes of Q&A. The three presentations will be on i) preliminary design concept, ii) actual design and implementation and iii) necessary modifications and the performance of their funds.

In addition, each team will read and make a short presentation on one of a handful of preapproved books relevant to QF. Student teams will also meet with me privately from time to time, but the class will not be responsible for any material covered in private meetings with me unless it is also covered in class.

Ethical Conduct

|Stevens Honor System: Enrollment into the undergraduate class of Stevens signifies a student’s commitment to the Honor System. It|

|is the responsibility of each student to become acquainted with and to uphold the ideals set forth in the Honor System |

|Constitution. All students are reminded that, as a condition of being admitted to Stevens, they will uphold and adhere to the |

|standards of the Stevens Honor System. Specific student responsibilities include: |

|Maintaining honesty and fair play in all aspects of academic life at Stevens |

|Writing and signing the pledge, in full, on all submitted academic work |

|Reporting any suspected violations to an Honor Board member or to the Dean of Undergraduate Academics |

|Cooperating with the Honor Board during investigations and hearings |

Schedule

Day 1 9/1 Introduction:

What is QF and why do we care about it?

Background required for specifying variables and parameters in QF

Evaluation of Student Backgrounds.

Selection of Project Teams

Discussion of book selections and reports

Section I – Foundation for QF – September 1 through September 30

Day 2 9/3

Examples of Financial Markets

Stocks

Bonds

Futures, Options and Other Derivatives

Real Estate

Commodities

Other

Applications of QF

Valuing Assets or Liabilities

Evaluating Risks and Ratings

Setting Regulatory Framework

Day 3 9/8 Legal Aspects of a Corporation relevant to QF.

Book selection due date

Limited Liability

Seniority of the Corporate Structure - bankruptcy

Basic taxes

QF Relevance – payoff scenarios

Day 4 9/10 Basic GAAP accounting required for QF

Assets

Liabilities

Equity

QF Relevance – i.e. book/market value screens

Day 5 9/15 Basic GAAP accounting required for QF

Income Statement

Revenue

Expenses including Interest

Earnings

Taxes

Depreciation

Amortization

QF Relevance – i.e. price to earnings or cash flow (EBITDA) screens

Day 6 9/17 First Project Team Presentations of initial QF design ideas

Day 7 9/22 Basic Economics and Finance required for QF

Supply and Demand

Utility Functions and Risk Aversion

Correlation

Variance

Simple Regression

QF Relevance – random walk, efficient markets

Day 8 9/24 Finish First Project Team Presentations of initial QF design ideas

Day 9 9/29 Basic Economics and Finance for QF

Price Earnings Ratios

Capital Asset Pricing Model

Risk Free and Risk Weighted Discount Rates

Calculation of Net Present Value and Internal Rate of Return

QF Relevance – Rho, beta, sigma squared, r specification in QF models

And in P/E, PEG and Tobin’s Q models

Day 10 10/1 Begin Student Book Reports

Day 11 10/6 Basic Economics and Finance for QF

Black - Scholes, Futures and Options Pricing Intro.

Efficient Market Theory

Random walk

Portfolio theory – Markowitz

Exchange Rate Theories

QF Relevance

Day 12 10/8 Finish Student Book Reports

Day 13 10/15 Midterm Exam

Section II – Basic Methods of QF – October 20 through December 10

Day 14 10/20 Basic Methods of QF

Moving Average and Momentum models

PE and PEG models

EBITDA

Other DCF, long short, other models

Day 15 10/22 Begin Second Project Team Presentations

Modified design and results to date

Q & A

Day 16 10/27 Guest Lecturer on QF investment models/algorithms TBA

Day 17 10/29 Complete Second Project Team Presentations

Day 18 11/3 Basic Methods of QF

Regression and basic time series

[Intro to Markov chains, S.D.E’s}

Day 19 11/5 Review Midterm Exam

Day 20 11/10 Bond Ratings, Credit Insurance and other wraps

Group discussion of “When Genius Failed”

Day 21 11/12 Guest Lecturer TBA on Value at Risk and other risk Models

Group Discussion of “The Black Swan”

Day 22 11/17 Class Trip to NYSE and/or Wall Street Trading Room

Day 23 11/19 Special Topics in QF

Customized swaps

Other exotic instruments

Margin

Day 24 11/24 Begin Final Project Team presentations

Day 25 12/1 Flexible class

Day 26 12/3 Finish Final Project Team Presentations

Day 27 12/8 Review class

Day 28 12/10 Review class

TUESDAY, DECEMBER 15 FINAL EXAM

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