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COURSE TITLE DERIVATIVES MARKETS (200 characters max) Title, name and surname of the coordinator dr Rafał Łochowski Course lecturers dr Rafał Łochowski lecture 30 hrs Semester: spring Instruction mode: direct Course description (1000 characters max) The course aims at profound understanding the specifics of derivative markets. Vast scope of real derivative instruments traded on world exchanges will be described: starting with plain futures/forwards, swaps, through vanilla options, exotic options, ending with advanced financial instruments (like CDS or CDOs) with different underlying assets, like volatility, interest rates, credit, wheather or commodities. Both theoretical (pricing) and practical (trading, risk management) aspects are going to be addressed. The lecture will be conducted mainly via multimedia slideshows complemented by internet websites. Upon starting the course students are expected to have micro- and macroeconomic background as well as intermediate skills in mathematics and probability/statistics. Final exam test is scheduled to complete the course, one minor written work in the mid-semester and project carried out during the classes. Course outline (65000 characters max) LECTURE 1. TRADABLE UNDERLYING ASSETS AND THEIR DERIVATIVES OUTLINE - main classes of tradable assets on spot markets and their description: stocks, bonds, indices, currencies, commodities, fund certificates - idea of derivative instruments, purposes: hedging, arbitrage, speculation -outline of the history of derivative instruments LECTURE 2. PLAIN DERIVATIVES - forward/future contract description, properties, pricing, application -examples of futures contracts for different underlying assets (stocks, currencies, commodities) -examples of hedging with the use of plain derivatives LECTURE 3. PLAIN DERIVATIVES, cont. - term structure (contango, backwardation) -determination of forward and futures prices - other plain derivatives: swaps and interest rates futures LECTURE 4. STOCK OPTIONS - European vanilla options: call/put; payoff profiles, specification, properties (put-call parity) - examples of hedging with the use of vanilla options - examples of speculation using options, leverage effects, examples of spectacular losses in derivatives markets - option strategies and their applications (strangle, butterfly, bull/bear spread, etc.); synthetic options LECTURE 5. STATISTICS OF STOCK MARKETS - returns, log-returns of financial time series - modeling distribution of returns and log-returns - consequences of assumption about normal distribution of log-returns - normal random walk as a model of evolution of logarithm of stock prices - measuring value at risk in normal random walk model LECTURE 6. MODELLING DYNAMICS OF STOCK PRICES AND STOCK OPTION PRICING - estimating parameters of random walk - dift and volatility - continuous random walk model – Brownian motion (information) - geometric Brownian motion and Itô formula (information) - Black-Scholes formulas for option prices LECTURE 7. FURTHER PROPERTIES OF BLACK-SCHOLES-MERTON MODEL - Greek parameters - implied volatility, volatility smile, volatility surfaces LECTURE 8. OTHER TYPES OF STOCK OR INDEX OPTIONS – EXOTIC OPTIONS. VOLATILITY INDEX (VIX) and VIX OPTIONS - barrier options, binary options, lookback options, Asian options - CBOE volatility index (VIX), specification and interpretation - VIX options and their features LECTURE 9. DISADVANTAGES OF BLACK-SCHOLES MODEL - non-normality of stock returns, volatility clustering, heavy tails - alternative models (Heston model) - extreme events (market crashes), measuring risk in the presence of heavy tails LECTURE 10 INTEREST RATE DERIVATIVES - different interest rate options (European bond and swap options, interest rate caps and floors) - Black's model - short rate models: Vasicek model, CIR model, Black-Karasinski model - HJM model LECTURE 11. CREDIT RISK AND CREDIT DERIVATIVES - default probabilities - Merton model LECTURE 12. CREDIT RISK AND CREDIT DERIVATIVES cont. - CDS (credit default swaps), forwards and options - CDOs (collateralized debt obligations) LECTURE 13 WEATHER DERIVATIVES - temperature as an underlying “asset” of weather derivatives - modeling temperature dynamics (Ornstein-Uhlenbeck process) - examples of weather derivatives and pricing - main buyers of weather derivatives ((re-)insurance companies, mass-event organizers) LECTURE 14 ENERGY DERIVATIVES - stylized facts of energy markets (energy as a non-storable good with highly non-constant demand) -brief description of deregulated energy markets across the world (EU, USA, Australia) - examples of energy derivatives LECTURE 15. OTHER DERIVATIVE MARKETS, SUMMARY - commodity derivatives - freight derivatives - summary Official requirements Course prerequisites Knowledge of capital markets basics, i.e.: stock, bonds, stock exchange, investment. Micro- and macroeconomy and their basic mechanisms. Intermediate skills in mathematical analysis, probability, statistics. Introductory guidelines The sufficient background in mathematics is necessary to understand theories and models presented during the course. Learning outcomes (4000 characters max) Students will acquire profound knowledge about derivative instruments, including: specifics of futures, various classes of options, swaps and alternative derivatives. The course's main aim is to popularize the specifics of derivatives with their broad practical usage possibilities (hedging, diversification, speculation). Theoretical aspects as pricing are to be confronted with real market trade. On finishing the course students possess versatile knowledge encompassing theoretical and practical aspects of derivatives markets. Classes perform a complementary role of enhancing theoretical and practical aspects. Assessment criteria and evaluation methods ( 4000 characters max) Main final examination test comprising of about twenty relatively short questions/problems is intended as key knowledge verification. It comprises 50 % of total score. Halfway through the course minor written work checking the students' present progress is planned, entailing 15% of total score. The remaining pool will be granted for the project which will be carried out during the classes. Course type (1000 characters max) lecture Form of course crediting written exam Course mode (1000 characters max) Common multimedia-style lecture possibly aided with internet websites. Language of instruction: Readings (65000 characters max) Suggested: Hull J. C., Options, Futures and Other Derivatives; Prentice Hall 2005 or later Wilmott P., Paul Wilmott Introduces Quantitative Finance, Wiley 2007 Complementary: Wilmott P., Paul Wilmott on Quantitative Finance, Vol 1-3, Wiley 2006 Geman H., Commodities and Commodity Derivatives: Modelling and Pricing for Agriculturals, Metals and Energy, Wiley 2005