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Centre for Financial and Management Studies (CeFiMS)

Derivatives

Course Code:
C333
Unit value:

Introduction

This course focuses on the conceptual and analytical aspects of derivatives in financial markets. In studying this course you will learn the main features of the most commonly used financial derivatives and will understand how to use them for the management of risk. You will be able to understand the main characteristics of derivatives and it is hoped you will be able to avoid some of the most dangerous pitfalls from their use. The course is not a substitute for the professional expertise that can only be acquired by directly working in financial markets. However, you will find that the course will provide a sound grounding in the principles of derivatives, enabling you to understand much better the practical aspects of derivatives investment and risk management.

Resources

Study Guide

You will receive a looseleaf binder containing eight 'course units'. The units are carefully structured to provide the main teaching, defining and exploring the main concepts and issues, locating these within current debate and introducing and linking the further assigned readings. The unit files are also available to download from the Online Study Centre.

Textbook

John C. Hull (2009) Options, Futures, and Other Derivatives, Seventh Edition, Upper Saddle River, New Jersey: Pearson Education Inc.

This is a classic textbook on derivatives, written by an authority in the field and covers both theoretical and practical aspects in the use of derivatives. This edition also explains a number of recent events and analyses relevant case studies in financial markets.

The textbook by Hull comes with a CD that contains the proprietary software DerivaGem. This software enables you to compute the prices of a large number of derivatives and to draw the relevant graphs.

Online Study Centre

You will have access to the OSC, which is a web-accessed learning environment. Via the OSC, you can communicate with your assigned academic tutor, administrators and other students on the course using discussion forums. The OSC also provides access to the course Study Guide and assignments, as well as a selection of electronic journals available on the University of London Online Library.

Objectives and learning outcomes of the course

By the end of this course you will be able to:

  • Apply the principles of hedging and dynamic hedging;
  • Understand the Black-Scholes model and its applications:
  • Calculate delta and other measures of sensitivity;
  • Evaluate interest rate swap contracts;
  • Discuss the role of credit derivatives in risk management;
  • Apply appropriate numerical methods for analysing derivatives.

Scope and syllabus

Course Units
Unit 1: Derivatives Contracts
  • 1.1 Introduction
  • 1.2 Forward Contracts
  • 1.3 Futures Contracts
  • 1.4 Types of Traders
  • 1.5 A 'Health Warning'
  • 1.6 Conclusions
Unit 2: Properties of Stock Options
  • 2.1 Options
  • 2.2 Stock Options
  • 2.3 Warrants, Employee Stock Options and Convertibles
  • 2.4 Basics of Pricing Stock Options
  • 2.5 Trading Strategies Involving Options
  • 2.6 Conclusions
Unit 3: The Behaviour of the Stock Price and the Black-Scholes model
  • 3.1 Introduction
  • 3.2 The Wiener Process
  • 3.3 The Behaviour of Stock Prices
  • 3.4 Itô's Lemma
  • 3.5 The Lognormal Property of Stock Prices
  • 3.6 The Black-Scholes-Merton Equation and the Black-Scholes Formula
  • 3.7 Conclusions
Unit 4: Greek Letters and Trading Strategies
  • 4.1 Naked and Covered Positions
  • 4.2 Delta Δ Hedging
  • 4.3 Theta Θ
  • 4.4 Gamma Γ
  • 4.5 Vega v
  • 4.6 Rho ρ
  • 4.7 Hedging and Portfolio Insurance
  • 4.8 Conclusions
Unit 5: Interest Rate Models
  • 5.1 Interest Rates
  • 5.2 Forward Rates
  • 5.3 Management of Bond Portfolios
  • 5.4 Swaps
  • 5.5 Currency Swaps
  • 5.6 Bond Options
  • 5.7 Conclusions
Unit 6: Credit Derivatives and Credit Risk
  • 6.1 Credit Ratings and Default Probabilities
  • 6.2 Mitigation of Credit Risk and Default Correlation
  • 6.3 Credit Default Swaps
  • 6.4 Asset-Backed Securities and Collateralized Debt Obligations
  • 6.5 Correlation and the Gaussian Copula
  • 6.6 Conclusions
Unit 7: Some Exotic Options
  • 7.1 Exotic Options
  • 7.2 Barrier, Binary, and Lookback Options
  • 7.3 Asian Options
  • 7.4 Some Other Exotic Options
  • 7.5 Weather and Energy Derivatives
  • 7.6 Insurance Derivatives
  • 7.7 Conclusions
Unit 8: Further Numerical Procedures
  • 8.1 Binominal Trees
  • 8.2 Alternative Procedures for Constructing Trees
  • 8.3 Monte Carlo Simulations
  • 8.4 Finite Difference Methods
  • 8.5 Alternatives to Black-Scholes
  • 8.6 Stochastic Volatility Models
  • 8.7 American Options
  • 8.8 Conclusions

Method of assessment

You will complete two assignments, which will be marked by your course tutor. Assignments are each worth 15% of your total mark. You will be expected to submit your first assignment by the Tuesday of Week 5, and the second assignment at the end of the course, on the Tuesday after Week 8. Assignments are submitted and feedback given online. In addition, queries and problems can be answered through the Online Study Centre. You will also sit a three-hour examination on a specified date in October, worth 70% of your total mark. An up-to-date timetable of examinations is published in April of each year.