Faculty of Business: Finance and Economics
Credit points: 6 cp

Subject level: Undergraduate

Result Type: Grade and marks

Requisite(s): 25503 Investment Analysis OR 25906 Portfolio Theory and Investment Analysis (Advanced)
These requisites may not apply to students in certain courses.
There are also course requisites for this subject. See access conditions.

Handbook description

This subject provides a basic understanding of forwards, futures, swaps and options. It covers their valuation by arbitrage arguments, their use and the management of the associated risks. A large part of this subject is devoted to applied problems dealing with situations in which students may expect to encounter derivations in practice.

Subject objectives/outcomes

On successful completion of this subject students should be able to:

1. Understand derivatives pricing and use standard pricing formulae
2. Understand financial risks and nature of interest rate risk exposure
3. Understand how derivatives can be replicated by trading strategies in the underlying assets
4. Calculate and interpret Value at Risk.

Contribution to graduate profile

This subject provides students with a basic understanding of derivative financial instruments, their use, their valuation and the management of the associated risks. Derivatives play an important role in managing the risk of stock portfolios and may also be used in the pricing of equity and debt of a firm. The material covered in this subject has far reaching application to both investments and corporate finance and is therefore of prime relevance to the Finance major.

Teaching and learning strategies

The subject content will be covered in standard lecture mode. Materials covered in the lectures are reinforced by discussion of tutorial problems.

Content

• Relationship between forward, futures and spot prices
• Hedging strategies using financial futures and forward
• Nature of swaps and how they are valued
• Basic properties of stock options and the trading strategies
• Option pricing using binomial trees and the Black and Scholes model
• Modifications of the Black and Scholes model to option valuation
• Hedging positions in options and synthetic options
• Value at Risk, calculations, interpretations and its limitations.

Assessment

Assignment (Group and Individual)	20%
The assignment comprises two parts. Part A includes problems on topics covered in the first five lectures. Part B covers problems on the remaining course content. It is to be completed in group by students during the semester. The assignment thus assures objectives 1-4.
Mid-Semester Examination (Individual)	30%
The mid semester examination will assess students' understanding of the use and valuation of basic derivatives, which can be replicated by static portfolio strategies, i.e. forwards, futures and swaps. It assures objectives 1-3.
Final Examination (Individual)	50%
The final examination will require students to demonstrate that they have met objectives 1-4. It tests their proficiency in applying the techniques to hedging and arbitrage scenarios.

Examinations will be conducted under University examination conditions, and hence thoroughly address concerns regarding secure assessment. The assignment will be secured through a combination of updating of assessment tasks across semesters and/or plagiarism detection software.

Recommended text(s)

Hull, J. (2008) Fundamentals of Futures and Options Markets, 6th ed. Pearson Prentice-Hall.

Indicative references

Chance, D.M. (2003) Analysis of Derivatives for the CFA® program, Association for Investment Management and Research.

Chance, D.M. (2004) An Introduction to Derivatives and Risk Management, 6th ed. Thomson/South-Western, Ohio.

Kolb. R.W. & Overdahl, J.A. (2007) Futures, Options and Swaps, 5th ed. Blackwell, Mass.