Derivatives Markets (FINC-465-0)
This course introduces forwards, futures, options and related financial contracts, which are widely used for risk management in the form of standardized derivative securities, but also represent features that are found in common corporate securities, not typically thought of as derivatives. The course develops in depth a conceptual and analytical framework for understanding the pricing of these features, as well as strategies for managing risk. Covered topics include the following. Basic risk-management strategies using forward contracts, call and put options. Arbitrage relationship between spot prices and forward prices based on the role of dividends, cost of carry and convenience yields, with applications to securities lending, commodities and foreign exchange. An overview of futures markets: OTC markets versus exchanges, mark-to-market, margins, the role of clearinghouses. Statistical hedging with futures and the notion of basis risk. Introduction to swaps as a natural extension of forwards and futures. Fundamental option-pricing results such as put-call parity (including for hard-to-short stocks), general patterns in the optimal exercise of American options, and how the pricing of risk relates to the time horizon. Binomial pricing and hedging, and its limiting Black-Scholes model and associated hedging and market-making techniques. Overview of option pricing applications in corporate and other settings.