Derivatives and Financial Markets Syllabus

Instructor: Jim Bodurtha

Office: Old North 313

Phone: 202 687-6351

Fall Office Hours: M W 10:15am-11:45am and by appointment

Winter Office Hours: M W 11:40am-1:00pm and by appointment

Prerequisites: A full semester of Financial Management. Therefore, the student must have a good understanding of discounted cash flows. Additionally, the student should be comfortable with statistics (e.g. expected values, standard deviations and probability distributions) and math-calculus (e.g. differentiation, integration, e and natural logarithms.) Generally, students have also taken a corporate finance course and/or an investments course.

Description: This course program is designed to expand participants' understanding of derivative-related financial instruments (forwards, futures and options) and their use in investment and corporate financial management.

Objectives: To provide a basic understanding of derivatives and introduce the analytics of derivative valuation.

To provide practical and simple investment and corporate financial management strategies using derivatives in a manner which will allow students to apply these concepts and skills.

To practice meeting investment and corporate finance objectives with derivatives, using a series of examples.

As the class-notes are in overhead form, you will need the text. The class note modules all have cross-references to the appropriate sections of the Hull book. It is also recommended that you keep up with the financial press. The FT-US and WSJ are good daily sources. The Wall Street Journal provides discount student subscriptions on a quarterly or a semester basis (click to access) -- as does the FT for students. Weekly sources include The Economist, Barron's, Business Week, Fortune, and Forbes.

Calculation: The course will require a significant amount of calculation and/or computer spreadsheet work. Please always bring your financial calculator to class.

Grading: A series of 200 point quizzes will be given at approximately three week intervals through out the semester and during the assigned final exam period. A risk management project is also due before our final exam session, and a project work update is required at mid-semester. The grade weight of the final project is equal to two quizzes (400 points). Historically, project grades have averaged 90-91 on a 100 point scale. The final exam period quiz is equal to 1/2 of a regular quiz (you will not have to study for this quiz - but more on that later in the semester.)

As this course concerns derivatives, you earn two grading options by taking the first quiz as scheduled: You will have the option to exclude one quiz from your final grade calculation. Additionally, you will have the option to redo one quiz question per quiz to earn back half of the points lost on the question. The options are inclusive, i.e. you have both options.

There will be no quiz make-ups. If, for some reason - like snow, a quiz must be canceled for the entire class, then the next quiz will count as a double quiz.

Finally, on all quizzes subsequent to the first one, you earn 180 out of 200 quiz points for your work on the quiz. You earn the additional 20 points by attending and participating in class during the three weeks leading up to a quiz. If you do miss a class or have negative participation, then I will evaluate your excuse out of 3-5 points per class. Obviously, there will be a sign-up sheet handed out for each class, and I ask you to sit in the same seat through out the semester.

There will be a series of required homeworks, from 1-3 per assignments per module. Homework will be distributed in class. The homeworks are also available on the class web site, as are suggested homework answers. Any homework that is unsatisfactory or missed will result in a 10 point penalty on the associated quiz. I require that all homework be turned in with the associated quiz.

Class grades are not curved, and the letter grade cutoffs (with no rounding up) are the following: A 95, A- 91, B+ 89, B 85, B- 81, C+ 79, C 75, C- 71, D 67, and below 67 is an F.

I recommend that you look over the sections in the following Hull book before the material is covered in class.

Class notes, quizzes and homework are in *.pdf or Adobe Acrobat form. If these files don't load when you click on the hyperlink line, then click for Acrobat download .

Review: Time Value of Money and Interest Rates
Options 6^th: 4.2-4.3 especially, 4.1-4.10, 6.1-6.2 (optional 6.5-6.6)
Options 5^th: pg. 42-44, 5.1-5.9, 5.13-5.14
Options 4^th: pg. 50-53, 4.1-4.9, 4.13-4.15

Notation: Abbreviations and Symbols

1. Forward and Futures Prices
Options 6^th:1.3, 5.3-5.7
Options 5^th:1.3, 3.4 - 3.8
Options 4^th: 1.1, 3.1 (pp. 53-59) - 3.5

2. Volatility Basics
Options 6^th: 13.1-13.2, 13.4, 18.1, 19.1-19.2; optional 13.3, 13.11, 18.2-18.3, 19.3-19.6
Options 5^th: 12.1-12.2, 12.4, 16.1, 17.1-17.2; optional 12.3, 12.11-12.12, 16.2-16.3, 17.3-17.6
Options 4^th: 11.1-11.3, 14.1-14.2, 15.1-15.2; optional 15.3-15.7

3. Price Risk
Options 6^th: 5.15, 18.1, 18.6-18.8 and 18.summary; optional Chapter 3, 18.4-18.5 and 18.9
Options 5^th: 3.15, 16.1, 16.6-16.8 and 16.summary; optional Chapter 4, 16.4-16.5 and 16.9
Options 4^th: 3.12, 14.2, 14.7-14.9, 14.summary

4. Forwards and Futures (optional session for MBAs)
Options 6^th: 1.4, Chapter 2, 5.9-5.12; optional: 5.13- 5.14, 6.3-6.4, Chapter 7 (Not 5.Appendix proof)
Options 5^th: 1.4, Chapter 2, 3.9-3.12; optional: 3.13- 3.14, 5.10-5.12, Chapter 6 (Not Appendix 3A proof)
Options 4^th: 1.2, Chapter 2, 3.6-3.9; optional: 3.10- 3.11, 4.10-4.12 (Not Appendix 4A proof)

5. Option fundamentals: calls, puts, and underlying
Options 6^th: 1.5-1.7, Chapters 8 and 9
Options 5^th: 1.5-1.7, Chapters 7 and 8
Options 4^th: 1.3, 1.4, Chapters 6 and 7

6. Option Positions and Strategies
Options 6^th: Chapter 10
Options 5^th: Chapter 9
Options 4^th: Chapter 8

7. Black-Scholes-Merton Model Sensitivities
Options 6^th: Chapters 13 and 14; optional Chapter 15
Options 5^th: Chapters 12 and 13; optional Chapter 14
Options 4^th: Chapters 11 and12; optional Chapter 13

8. Binomial and Black-Scholes Option Valuation
Options 6^th: 11, 17.1-17.5; optional 12, 17.6-17.9
Options 5^th: 10, 18.1-18.5; optional 11, 18.6-18.9
Options 4^th: 9, 16.1-16.5; optional 10, 16.6-16.9

9. Implied Volatility
Options 6^th: 13.1, Chapter 16; optional Chapter 19
Options 5^th: 12.10-12.11, Chapter 15; optional Chapter 17
Options 4^th: 11.10-11.11, Chapter 17; optional Chapter 15

10. Synthetic Options and the Cost of Insurance
Risk Management - full text version
Options 6^th: Chapters 3 and 18
Options 5^th: Chapters 4 and 16
Options 4^th: Chapter 14

Additional Suggested References -
Bodurtha, J. and Courtadon G., The Pricing of Foreign Currency Options, New York, Salomon Brothers Center, New York University, 1987-4/5.
Chance, D., An Introduction to Derivatives, New York, Dryden, 1998.
Cox, J. and M. Rubinstein, Options Markets, Englewood Cliffs, N.J., Prentice-Hall, 1985, ISBN 0136382053.
Figlewski, S., W. Silber and M. Subrahmanyam, Financial Options, : From Theory to Practice, Homewood, Illinois, Business One Irwin, 1990, ISBN 1556232349.
Jarrow, R.A. and A. Rudd, Option Pricing, Homewood, Illinois, Dow Jones-Irwin, 1983, ISBN 0870943782.
Jarrow, R.A. and S. Turnbull, Derivative Securities, Cincinnati, Ohio, South-Western, 1996.
McDonald, R., Derivatives Markets, Boston, MA, Addison-Wesley Publishing, 2002, ISBN: 0201729601.
Rubinstein, Mark, In-the-Money, http://www.in-the-money.com/body.htm, hard copy is Rubinstein on Derivatives, London, Risk Books, ISBN 1899332537.
Stoll, H. and R. Whaley, Futures and Options: Theory and Applications, Cincinnati, Ohio, South-Western, 1993, ISBN 0538801158.

Derivatives Used in Practice -
Bookstaber, R.M., Option Pricing and Investment Strategies, Chicago, Probus, 1991, ISBN 1557381453.
Gastineau, G.L., The Stock Options Manual, 3rd edition, New York, McGraw-Hill, 1988, ISBN 0070229813.
Gatheral, Jim, The Volatility Surface: A Practitioner's Guide, Hoboken, NJ, Wiley Finance, 2006, 9780471792512.
Kolb, R.W., Financial Derivatives, Miami, Kolb Publishing, 1993, ISBN 1878975188.
Kolb, R.W., Understanding Futures Markets, 3rd edition, Miami, Kolb Publishing, 1991, ISBN 187897503X.
McMillan, L.G., Options as a Strategic Investment, 3rd edition, New York, New York Institute of Finance, 1993, ISBN 0136360025.
Natenberg, S., Option Volatility and Pricing: Advanced Trading Techniques, 2nd edition, Chicago, Probus, 1994, ISBN 155738486X.
Schwarz, E.W., Financial Futures: Fundamentals, Strategies and Applications, Homewood, Illinois, Irwin, 1986, ISBN 0256030057.
Siegel, D.R. and D.F. Siegel, The Futures Markets, Chicago, Probus, 1990, ISBN 1557385726.
Smith, Jr., C.W. and C.W. Smithson, The Handbook of Financial Engineering, New York, Harper & Row, 1990, ISBN 0887304486.
Risk, From Black-Scholes to Black Holes, London, Risk, 1993, ISBN 0 9516453 31.
Taleb, Nassim, Dynamic Hedging: Managing Vanilla and Exotic Options, New York, Wiley, 1997, ISBN-10 0471152803, ISBN-13 978-0471152804.
Tompkins, R.G., Options Analysis, Chicago, Probus, 1994, ISBN 1557388342.

More technical -
Ingersoll, J., Theory of Financial Decision Making, Totowa, N.J., Rowman & Littlefield, 1987, ISBN 0847673596.
Shimko, D., Finance in Continuous Time: A Primer, Miami, Kolb Publishing, 1992, ISBN 1878975072.
Wilmott, Paul, J. Dewynne and S. Howison, Option Pricing: Mathematical Models and Computation, Oxford, Oxford Financial Press, 1993, ISBN 0952208202.