FINANCIAL DERIVATION

FINANCIAL DERIVATION
AREA OF STUDY: SPECIALIZATION FINANCE
BACVBF

Year: 4
Semester: 8

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* Continuous
** Duration: 3 hours

Course Objectives:
After completion of this the students will have a knowledge of when and how to use financial derivatives properly and not destroy an organization.
Unit I: Introduction L.H.4
1. Derivatives markets & Instruments; Options: Futures Contracts; Forward Contracts, Options on futures; Swaps and other Derivatives.
2. Concepts in Financial & Derivative Markets: Risk preference; short selling; return & risk.
3. Linkage between spot & derivative markets: Role of derivative market, misuse of derivatives.
Unit II: Structure of Options Market L.H.5
1. Development of Options Markets: Call Options; Put Options; Over-the-counter options markets; Organized Options Trading option price quotations.
2. Type of Options: Stock Options; Index Options; Currency Options.
Unit III: Principles of Options Pricing L.H.7
1. Principles of Call Option Pricing: Minimum value of a call, Maximum value of a call, Value of call at expiration, Effect of time to time expiration, Effect of early exercise, Lower bound of a European Call, Early exercise of American Call on dividend paying stocks, effect of interest rate, effect of stock volatility.
2. Principles of put option pricing: Minimum value of a put, maximum value of a put, value of a put, value of a put at expiration, effect of time to expiration, effect of exercise price, Lower bound of a European put, Early exercise of American puts, Put call parity, effect of interest rates, effect of interest rates, effect of stock volatility.
Unit IV: Option Pricing Models:
1. The one period Binomial model: hedge portfolio, overprice call, underpriced call.
2. Two period binomial model: hedge portfolio, mispriced call in the two period world.
3. Extensions of Binomial Model: pricing out options, American puts and early exercise; Dividends, European calls, American calls and early exercise.
Unit V: Option Pricing Model: The Black-Scholes Models:
1. Origin of the Black-Scholes Formula
2. Assumption of the model
3. Variables in the Black-Scholes Model: Exercise price, risk-free rate, volatility or standard deviation, time of expidation
4. Black-Scholes model when the stock pays dividends: known discrete dividends, know continuous dividend yield.
5. Put option pricing models, managing the risk of options.
Unit VI: Basic Option Strategies L.H.7
1. Profit Equation; Different holding periods; Assumption;
2. Stock Transactions; Call option transactions; Put options transactions; Covered call; Protective puts; Synthetic puts & calls
3. Options spread; Money spreads; Bull spreads, bear spreads, collars, butterfly spreads.
4. Calendar Spreads; Ratio spreads; Straddles; Box spreads.
Unit VII: Forward & Features L.H.8
1. Organized Futures Trading; Mechanism of Futures trading; Future price quotations.
2. Types of futures contrasts; Agricultural Commodities, Natural Resources. Foreign Currencies, Treasury Bills & Eurodollars, Treasury Notes & Bonds. Equities, Managed Funds, Hedge Funds, Options on Futures.
3. Properties of Forward and Future Prices: Concept of price versus value, value of a forward contract, value of futures contract, Forward and future prices.
4. Forward & Futures Hedging Concepts: Short hedge & Long hedge, risk of hedging, margin requirements and making to the market.
5. Determinants of the Hedge ratio Minimum variance hedge ratio, price sensitivity hedge ratio, stock index futures hedging.
6. Hedging strategies Foreign currency hedge, Intermediate & long term interest rate hedges, stock market hedges.
Unit VIII: Swaps:
1. Interest Rate Swaps: Currency swaps: Equity swaps:
2. Structure, pricing and valuation, and swap strategies.
Suggested Readings:
1. Options, Futures, and Other Derivatives, John C. Hull. Prentice Hall of India.
2. An Introduction to Derivatives & Risk Management, Don M. Chance, Thomson Asia Pvt. Ltd.
3. Investments, Sharpe, Alexander & Bailey, Prentice Hall of India.
4. Investments, Bodie Kane, Marcus, Tata McGrow Hill.