Finance 465: Derivatives Markets I
A rigorous and quantitatively demanding course on futures, options and related derivative securities, with emphasis on arbitrage pricing and hedging methods.
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 forward contracts 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. Overview of option pricing applications in corporate and other settings.
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 textís even-numbered questions. These are intended for self-study only. Please note: The solutions refer to the second edition. I will post solutions to the third edition as soon as I receive them. If you already have the second edition, you do not need to purchase the third edition for this course. If you are planning to purchase the text, you should get the latest edition.
course grade is the maximum of the following two weighted averages
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:† TBD
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