F71DV - Derivatives Markets and Pricing

Course leader(s):

Anke Wiese (Edinburgh, September)

Aims

The aims of this course are:

To provide a thorough grounding in the operation of derivative markets
To provide an introduction to the methods of hedging using option and forward contracts, with particular emphasis on bond (interest rate) markets
To provide students with a good understanding of the principles of no-arbitrage pricing
To introduce mathematical concepts related to stochastic processes
To teach students the CRR (discrete time binomial) model for derivative pricing
To introduce the Wiener process and the BSM option pricing model

Syllabus

1. Derivative Products and Markets (1.1 Introduction to Derivatives and Derivatives Markets , 1.2 Options, 1.3 Forwards and Futures)

2. Interest Rate Derivatives and Swaps (2.1 Interest Rate Derivatives, 2.2 Swaps and Exotics)

3. Derivative Pricing in Binomial Models (3.1 Option Pricing in Binomial Models, 3.2 Mathematical Theory of Binomial Trees)

4. Derivative Pricing in Continuous-Time Models (4.1 Recombining Binomial Trees and Introduction to Continuous-Time Finance, 4.2 Itô Calculus, 4.3 Ito's Formula and the Black-Scholes-Merton Partial Differential Equation)

Learning outcomes

By the end of the course, students should be able to do the following:

demonstrate knowledge of the basic characteristics of derivatives markets, the role of market participants, and explain the core characteristics of standard financial derivatives and their use in risk management.

apply principles of no-arbitrage and replication to determine forward and futures prices.

explain how futures contracts can be used for risk management purposes and derive optimal hedging strategies.

explain the core characteristics of different types of interest rates, and their connections, the characteristics and use of traded interest-rate derivatives.

demonstrate an understanding of how credit risk affects the derivatives market.

demonstrate knowledge and understanding of the mathematical theory underpinning the pricing and replication of derivative instruments in the binomial model and in the Black-Scholes-Merton model.

apply financial mathematics methods to derive derivatives prices and hedging strategies.

apply mathematical methods to derive the Black-Scholes-Merton partial differential equation.