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This subject focuses on the application and valuation of derivative securities, such as forwards, futures, swaps and options. The emphasis will be on arbitrage relations, valuation, and hedging with derivatives. The topics covered include; Forwards and futures: the mechanics of trading, price determination, hedging strategies; Swaps: definition and valuation; Options: payoffs, arbitrage bounds, trading strategies, the binomial model, the Black-Scholes model and its relationship to the binomial, hedging, American options and dividends, options on futures, limitations of the binomial and Black-Scholes Models.
Intended learning outcomes
On successful completion of this subject students should be able to:
- Explain the role of derivatives exchanges and the characteristics of derivative securities;
- Explain the role of arbitrage as a basis for determining the prices of derivative securities;
- Explain the mechanics of trading futures contracts, forward contracts and options;
- Design and manipulate payoff diagrams for various derivative securities;
- Calculate option prices using the Black-Scholes and binomial models;
- Explain how derivative securities can be used in hedging;
- Reflect on the theoretical limitations of key derivatives pricing models and on practical difficulties that arise in their implementation.
High level of development: problem solving; statistical reasoning; application of theory to practice; synthesis of data and other information; evaluation of data and other information.
Moderate level of development: written communication; interpretation and analysis; critical thinking; use of computer software.
Some level of development: oral communication; collaborative learning; team work; accessing data and other information from a range of sources.
Last updated: 22 January 2022