| CODE | BKF5230 | |||||||||
| TITLE | Financial Derivatives | |||||||||
| UM LEVEL | 05 - Postgraduate Modular Diploma or Degree Course | |||||||||
| MQF LEVEL | 7 | |||||||||
| ECTS CREDITS | 5 | |||||||||
| DEPARTMENT | Banking and Finance | |||||||||
| DESCRIPTION | The objective of this unit is to provide a conceptual framework for understanding the financial risk management decision making of financial institutions and other corporations operating in an international context, and to provide insights into financial risk management strategy using derivative instruments. The main theme of the unit is to evaluate the pricing and use of such financial instruments for institutions operating in an environment of fluctuating exchange rates, differential international rates of inflation, differing money market conditions and government regulation. Our focus throughout will be on interest rate and currency products rather than equity-related derivatives. While derivatives is one of the most mathematically sophisticated areas of finance, users of derivatives need to be able to explain the fundamental principles of derivative pricing and risk management in a conceptual manner without the use of advanced mathematical modeling. This unit provides a formal and rigorous approach to financial derivatives, yet also one which is intuitive and accessible without the use of advanced mathematics. The course will have a strongly applied orientation, and case study/problem solving material will be used whenever appropriate. The course assumes that the student has a basic knowledge of the major international financial markets from previous courses. Study-unit Aims: Upon successful completion of this study-unit, students should: 1. be familiar with the structure and characteristics of the major interest rate and currency derivates and the markets in which they trade, 2. have a conceptual and practical understanding of the pricing of the major interest rate and currency derivatives, including forwards, futures, FRAs and interest rate and currency swaps, 3. have a conceptual and practical understanding of the notion of option payoffs, and how to price a simple option by arbitrage strategies involving replication of cash flows and hedging cash flows. Learning Outcomes: 1. Knowledge & Understanding: By the end of the study-unit the student will be able to: 1. have a conceptual and practical understanding of the role of volatility in pricing options and the concept of a volatility smile. 2. have a conceptual and practical understanding of the concept of put-call parity and other basic option portfolio strategies such as straddles, collars, butterfly spreads etc. 3. have an understanding of the basic properties and characteristics of the major credit derivative instruments. 2. Skills: By the end of the study-unit the student will be able to: 1. Comprehed the fundamental concepts of derivatives. 2. Use these instruments for Portfolio Management and hedging of financial risk. 3. Have a solid understanding of how to trade these instruments. Main Text/s and any supplementary readings: The following texts are referred to throughout the course. The initial two texts listed are the recommended texts. Handouts will be provided in electronic form (pdf files) for all the core lecture notes and examination reading material. These wil be posted on the course website. Some Core Texts to which students may also wish to refer for reference material: Main Text : R.Sundaram and S. Das, Derivatives: Principle s and Practices, McGraw-Hill, 2011 (henceforth, DPP) Main Text: J.Hull, Fundamentals of Futures and Options Markets, Pearson, 7th edition, 2011. (Henceforth, FFOM) Also useful is: K.Cuthbertson and Dirk Nitzsche, Financial Engineering: Derivatives and Risk Management, Wiley, Chichester. 2001. (Henceforth, FE) Abbreviations AER: American Economic Review EJ: Economic Journal JIBS: Journal of International Business Studies JMCB: Journal of Money, Credit and Banking JEP: Journal of Economic Perspectives OEP: Oxford Economic Papers JIMF: Journal of International Money and Finance JF: Journal of Finance JPE: Journal of Political Economy Section 1 is for review. This covers material taught in the course on International Finance that you will have taken previously. The present unit will presume knowledge of this material. The material in this unit commences in Section 2. 1. THE INTERNATIONAL FINANCIAL ENVIRONMENT (REVIEW ONLY) Introduction and overview of trading activity in derivatives on other instruments in foreign exchange markets, international money markets, international capital markets, and international equity markets. Bank for International Settlements, Triennial Survey of Foreign exchange and Derivatives market activity, Dec. 2010 (or latest available version) 2. DERIVATIVE PRODUCTS: PROPERTIES and PRICING 2.1 International Interest Rate linkages and the interrelationship between Foreign Exchange (FOREX) Rates and Interest Rates. The basic international arbitrage condition as a prelude to derivative pricing Spot and Forward FOREX Markets: Covered Interest Parity (Interest Rate Parity) - R.Sundaram and S. Das, DPP, Chap 3 -4. - K.Cuthbertson and Dirk Nitzsche, FE, Chap.4. - R.P.Melnick and W Kester, "Note on Fundamental Parity Conditions," Harvard Business School, mimeo, 1988. - L.S.Copeland, Exchange Rates and International Finance, Wokingham, Addison-Wellesley, Second Edition, Chap.3. 2.2 Managing Financial Risk. The financial instruments available and some applications in risk management: A: Interest Rate Products: FRA's, interest rate futures and interest rate swap markets. - R.Sundaram and S. Das, DPP, Chap 5-6. - C.W.Smithson, Managing Financial Risk, McGraw-Hill, New York, 1998, Chap 4-7. - K.Cuthbertson and Dirk Nitzsche, FE, Chap.5. - J.Hull, FFOM, Chap. 4, 6, 7. B: The Evolution of the Swap Market C.W.Smithson, Managing Financial Risk, McGraw-Hill, New York, 1998, Chap 8. C: Interest Rate Swaps - R.Sundaram and S. Das, DPP, Chap 23.1-23.5 - K.Cuthbertson and Dirk Nitzsche, FE Chap.14. - J.Hull, FFOM, Chap. 7. - J.Bicksler and A Chen, "An Economic Analysis of Interest Rate Swaps, JF, (July 1983), p.652. - T-S Sun et al "Interest Rate Swaps: An empirical Investigation", Journal of Financial Economics (Aug. 1993), pp.77-99. - R.Litzenberger, "Swaps: Plain and Fanciful", JF, 47, (1992), pp.831-850. - S.Turnbull, "Swaps: A Zero Sum Game", Financial Management (1987), pp.15-21. - C.Smith et al., "The Market for Interest Rate Swaps", Financial Management (1988), pp.34-44. - M.Arak et al., "Interest Rate Swaps: An Alternative Explanation", Financial Management, (1988), pp. 1-21. - C.W.Smithson, Managing Financial Risk, McGraw-Hill, New York, 1998, Chap 8. D: Foreign Exchange: FOREX Products, FOREX Futures Markets. - K.Cuthbertson and Dirk Nitzsche, FE, Chap. 4. - J.Grabbe, International Financial Markets, Chap. 5, Chap. 6. E: FOREX Options Markets - R.Sundaram and S. Das, DPP, Chap 7-13. - K.Cuthbertson and Dirk Nitzsche, FE Chap. 11. - J.Hull, FFOM, Chap. 13, 14. - M Garman and S Kolhagen: "Foreign Currency Option Values", JIMF, 3, (1983), pp.231-237. - J Orlin Grabbe, "The Pricing of Call and Put Options on Foreign Exchange", JIMF, (1983), pp.239-253. - I.Giddy, "Foreign Exchange Options", Journal of Futures Markets, 2 (1983), pp.143-166. - K.Amin and R.Jarrow, "Pricing Foreign Currency Options under Stochastic Interest Rates", JIMF, (1991), pp.310-329. F: Currency Swaps - R.Sundaram and S. Das, DPP, Chap 25. - K.Cuthbertson and Dirk Nitzsche, FE Chap. 14. - C Beidleman ed., Cross Currency Swaps, Business One Irwin, Illinois, 1992. - A.Melnick and S.Plaut, "Currency Swaps, Hedging and the Exchange of Collateral 11, (1992), pp.446-461. G: The Valuation of Swaps - R.Sundaram and S. Das, DPP, Chap 23.6ff. - V.Bansal, M.Ellis, and J.Marshall, "The Pricing of Short-Dated and Forward Interest Rate Swaps", Financial Analysts Journal, (1993), pp.82-87. - C.W.Smithson, Managing Financial Risk, McGraw-Hill, New York, 1998, Chap. 9. H: Measuring and Managing Transaction (Contractual), Economic (Operating), and Translation (Accounting) Exposure. - M.Adler and B.Dumas, "Exposure to Currency Risk: Definition and Measurement," Financial Management, 1, (1984), 41-50. 3: CREDIT RISK 3.1 Evaluating the Credit Risk of Financial Instruments - R.Sundaram and S. Das, DPP, Chap 31. - K.Cuthbertson and Dirk Nitzsche, FE, Chap.25. - J.Bessis, RMB, Chap.7-9, 22-24. - I.Cooper and A.Mello, "The Default Risk of Swaps", JF, (1991), pp.597-620. - D.Hsieh, "Assessing the Market and Credit Risks of Long-term Interest Rate and Currency Products", Financial Analysts Journal, 49, (1993), pp.74-79. - D.Giberti et al,. "The Valuation of Credit Risk in Swaps: Methodological Issues and Empirical Results", Journal of Fixed Income, 2, (1993), pp.24-36. - E.Sorensen and T.Bollier, "Pricing Swap Default Risk", Financial Analysts Journal, 50, (1994), pp.23-33. 3.2 Credit Derivatives – Credit Default Swaps - R.Sundaram and S. Das, DPP, Chap 31. - J.Hull, FFOM, Chap. 21. - R.Ghose ed., Credit Derivatives: Key Issues, BBA, London, 1997. - S.Das, Credit Derivatives, Wiley, Chichester, 1998. - R.Jarrow and S.Turnbull, "Pricing Derivatives on Financial Securities subject to Credit Risk," JF, 150, (1995), pp.53-85. |
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| STUDY-UNIT TYPE | Lecture | |||||||||
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| LECTURER/S | Michael Bowe |
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The University makes every effort to ensure that the published Courses Plans, Programmes of Study and Study-Unit information are complete and up-to-date at the time of publication. The University reserves the right to make changes in case errors are detected after publication.
The availability of optional units may be subject to timetabling constraints. Units not attracting a sufficient number of registrations may be withdrawn without notice. It should be noted that all the information in the description above applies to study-units available during the academic year 2025/6. It may be subject to change in subsequent years. |
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