Course co-ordinator(s): Dr Giovanni Rabitti (Edinburgh), Dr Karamjeet Singh (Malaysia), Dr Larry O’Brien (Malaysia), Andres Barajas Paz (Edinburgh).
Aims:
To introduce the student to more advanced mathematical models of cashflows accumulated or discounted at interest, and to develop skill in applying these models to real financial contracts and transactions.
Summary:
This course builds on and extends the ideas contained in the related course F78AA Actuarial and Financial Mathematics A.
The concepts of a continuously-payable cashflow and the force of interest are considered, leading to a wider discussion of what is called the term-structure of interest rates and the yield curve.
The idea of indexing of cashflows, for example using a consumer price index, is introduced. This idea is applied to the valuation of index-linked securities.
Rates of return can be random and we see how to model and measure this risk. We see how interest-rate risk can be managed through the use of Redington’s immunisation theory. We understand and apply the no-arbitrage principle to price forward contracts.
Detailed Information
Course Description: Link to Official Course Descriptor.
Pre-requisites: none.
Linked course(s): F78AA Actuarial and Financial Mathematics A .
Location: Dubai, Edinburgh, Malaysia.
Semester: 2.
Syllabus:
- Nominal rates of interest
- Force of interest and continuous cash flows
- Duration and Redington's theory of immunization
- The term structure of interest rates
- Forward contracts
Learning Outcomes: Subject Mastery
On completion of this course the student should be able to:
- Describe and calculate nominal rates of interest.
- Know how to value and accumulate continuously-payable cash flows and how to calculate internal rates of return for transactions with such cash flows.
- Define the duration and convexity of a cash flow sequence and illustrate how these may be used to estimate the sensitivity of the value of the cash flow sequence to changes in the rate of interest.
- Know how duration and convexity are used in the immunisation of a portfolio of liabilities.
- Show an understanding of the term structure of interest rates and of the main factors influencing this structure.
- Calculate the delivery price and the value of a forward contract, using arbitrage-free pricing methods and to explain what is meant by hedging in the case of a forward contract.
- Know how to calculate the value of various types of forward contracts at any time during their duration.
- Use an appropriate computer package to apply the methods introduced in this course.
Learning Outcomes: Personal Abilities
- Interpreting problems from commercial practice in terms of relevant mathematical models
- Independently recognizing and applying appropriate mathematical techniques to solve problems
- Interpreting solutions expressed mathematically in terms of the original problem
- Communicating the solutions to complex problems in the financial services sector
Reading list:
- Garrett, S.J. (2013): An Introduction to the Mathematics of Finance: A Deterministic Approach. Oxford: Butterworth-Heinemann/Elsevier.
- Formulae and Tables for Actuarial Examinations (“Yellow Tables”). Published for the Institute and the Faculty of Actuaries.
SCQF Level: 8.
Credits: 15.
Other Information
Help: If you have any problems or questions regarding the course, you are encouraged to contact the course leader.
Canvas: further information and course materials are available on Canvas