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Finance 465: Derivatives Markets I Fall 2012 A rigorous and quantitatively demanding course on futures, options and related derivative securities, with emphasis on arbitrage pricing and hedging methods. Course Information Policies and Honor Code Course Materials and Announcements will be posted at the Northwestern Course Management System Prerequisites: Finance 430 or 440. Willingness to engage in analytically involved reasoning. Willingness to put in the effort required for conceptual understanding as opposed to memorization and mechanical plugging in of formulas. Topics: Introduction to forwards and options. Basic strategies for hedging or speculation using forward contracts, calls and puts. Arbitrage relationship between spot prices and forward prices, More elaborate forward pricing when the underlying pays dividends, cost of carry, securities lending, and convenience yields. Applications to commodities and foreign exchange. Overview of futures markets: OTC markets versus exchanges, mark-to-market, margins, the role of clearinghouses. The use of futures in basic hedging strategies. Introduction to swaps as a natural extension of forwards and futures. Put-call parity in ideal markets as well as for hard-to-short stocks. Further basic pricing restrictions on American and European options, and analysis of the optimal exercise policy for American options. Thorough and in-depth treatment of binomial pricing of options and associated hedging strategies. Discussion of limits to arbitrage. Introduction to the Black-Merton-Scholes option pricing theory, and associated risk management techniques. Recommended Text: Derivatives Markets, by Robert L. McDonald. The text is not strictly required, but it offers alternative explanations and additional material that most students find useful. Here are solutions to the text’s even-numbered questions. These are intended for self-study only. Grading: The course grade is the maximum of the following two weighted averages (A) problem sets 1/3, midterm 1/3, final 1/3 (B) problem sets 1/3, midterm 0, final 2/3 Homework Groups: Problem sets should be prepared in groups of up to four people. Only a single solution set per group should be turned in. You do not have to belong to the same group for every problem set. It is also OK to complete homework individually. Exams: The midterm and final exams will be in-class closed-book and closed-laptop, but you should bring a calculator with the exponential function. Office Hours: I am available in Evanston every Wednesday 3-4, in Chicago an hour prior to each lecture, or by special appointment. Please always email me in advance with the time you are planning to attend office hours. Teaching Assistant: Andrea Yinjia Lu frequently asked questions Some Related Links Finance news Financial Times Wall Street Journal Bloomberg Financial Information The Economist Yahoo! Finance Exchanges CME group Chicago Board of Options Exchange InterContinental Exchange NYSE Euronext Eurex, International Securities Exchange Other related links Commodity Futures Trading Commission Securities and Exchange Commission International Swaps and Derivatives Association Finra The Options Clearing Corporation