Syllabus - SIUE



Finance 431 Syllabus |Derivative Securities |Instructor: Rakesh Bharti | |

|Section 063 | |Address: 3147, Alumni Hall |

|Summer, 2005 |Contact: (618) 650-2549; rbharat@siue.edu |

Office Hours: 1:30-2:00 PM (TR); 5:30-6:00PM (WR); also by appointment

Required Text: An Introduction to Derivatives and Risk Management, Don Chance, 5th Edition, Harcourt.

Course Objectives:

A derivative security or a contingent claim represents a contract whose value depends on the value of another asset. A simple example would be an option to purchase the shares of a company at a mutually agreed upon price over the next nine months. Recently, the world has witnessed a remarkable expansion in the area of such financial instruments. The esoteric buzzwords like options, forwards, futures, swaps, caps, collars, etc. surface in the evening news. The global business community has embraced these new instruments for the purpose of hedging. Of course, given the zero-sum nature of these securities, it is easy to see that they lend themselves quite readily to speculative usage as well. In many cases, these instruments offer relief from the constraints imposed by regulatory structure, the tax code, and financial accounting standards.

The purpose of this course is to present the valuation theory and practice for these instruments. We will begin with an introduction to these instruments and the underlying arbitrage relationships as they provide a keen insight into their valuation. We will learn how futures and forward contract prices are related to the spot prices. Next, we shall cover the theory of option pricing using the Binomial and Black-Scholes Option Pricing Models. We will also address the shortcomings of these theoretical models and discuss ways of minimizing their impact on the effectiveness of the valuation or hedge. Finally, we shall study the derivatives on foreign currency, stock indices, commodities, and interest rates.

Components of Course Grade

Your course grade will be calculated on the basis of your performance in the following segments. The quizzes will be in-class and will test your knowledge of the topics under discussion. The final examination will be based on the material covered/assigned in the class.

|Segment |Marks |

|Project |100 |

|3 Quizzes (200 marks each) |600 |

|Final Examination |300 |

|Total |1000 |

Project

Derivatives pricing is essentially a highly computational subject. Students will have an opportunity to engage in pricing of traded options on equities. Each team of three undergraduates will select an exchange listed call and a put option from the Wall Street Journal quotes. To satisfy the Graduate School requirements, graduate students will work on the same assignment as an individual project. Next the valuation of those contracts will be performed using Microsoft EXCEL under the assumption that the two options are European. Next, as the options are actually American, they will be valued accordingly with the privilege of early exercise. These values should be comparable to the actually quoted value. Both Binomial Option Pricing Model and Black-Scholes Option Pricing Model will be used. Do bear in mind that Black-Scholes Option Pricing Model is only applicable to European options, or an American call with no dividends on the underlying. Use the average bid-ask discount for the T-bill with appropriate maturity to compute the risk-free rate from the same day’s Wall Street Journal. Assume no less than 60 periods for the binomial trees. Learning how to use EXCEL macros will eliminate the tedium. I shall give examples of the methodology as we proceed through the course. The project is due on the last class of the semester.

Schedule

The following course schedule lists the reading assignments. There is a considerable amount of material to be covered in this class. Although you may have been exposed to some of the material in prior finance classes, most of the material should be reasonably new to you. We shall go through these chapters sequentially. You should make every effort to read the assignment prior to the lecture to make the information easier to understand and more meaningful.

|Chapter |Title |

|1 |Introduction |

|2 |The Structure of Options Markets |

|3 |Principles of Option Pricing |

|4 |Option Pricing Models: The Binomial Model |

|5 |Option Pricing Models: The Black-Scholes Model |

|6 |Basic Option Strategies |

|7 |Advanced Option Strategies |

|8 |The Structure of Forward and Futures Markets |

|9 |Principles of Forward and Futures Pricing |

|10 |Futures Hedging Strategies |

|11 |Advanced Futures Strategies |

|12 |Options on Futures |

|13 |Foreign Currency Derivatives |

|14 |Interest Rate Derivatives |

|15 |Advanced Derivatives and Strategies |

|16 |Financial Risk Management |

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