FIN 524B Fall 2018

Derivatives
Fall 2018
Professor Alessio Saretto

Office: SH 201B
Office hours: Tuesday and Thursday 10:00 to 11:15, and by appointment.
Email: asaretto@wustl.edu
Phone: (314) - 935 2214
Teaching assistant: Dong Li (dong.li@wustl.edu)

Course Description
This course is designed to improve the student’s understanding of financial derivatives. The em-
phasis of the course is on developing the analytical skills necessary to utilize the basic mathematical
models which are most commonly used to price derivatives. Besides the technical aspects that
characterize the pricing of derivative securities, some institutional details will be presented.
This course assumes that this is the students’ second in-depth course in analysis and use of derivative
securities. The course is fairly quantitative and students should be familiar with the basic concepts
of financing decision making, calculus, probability and statistics (for example basic statistics such
as mean, variance, and correlation, and how to interpret regression analysis). Students should also
be comfortable using data analysis packages such as Excel, Matlab or equivalent.
Course grades will be determined as follows
Midterm I 25%
Midterm II 25%
Assignments 40%
Class participation 10%
Final grades will be given on a curve, according to University guidelines. There will not be any
opportunity to gain extra credit. If you wish some part of an homework or exam regraded, you
need to submit a request in writing within seven days from when the grade becomes public. The
entire homework or exam will be regraded. Your overall grade might be lower.

Exams
Midterm I is closed book and will be held in class. You must take the exams at the scheduled times.
I expect that you arrive on time, exit quietly, and conduct yourself properly during the exams.
Midterm II will be a take-home test and will be due on the last day of class. You are allowed to
discuss the take-home exam with your classmates, but you must complete it individually.

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Assignments
There will be 5 homework assignments. These assignments are to be completed individually. You
are allowed to discuss them with your classmates, but you must complete them on your own. All
assignment are due before the beginning of class as indicated below in the course outline. Each
assignment has an equal weight towards the 30% of the grade.

Academic Integrity
I take the Washington University Academic Integrity Code very seriously and expect that you will,
too. Your work in this course requires that you complete it individually; I will explain permissible
collaboration. I encourage you to ask me if you have any questions about academic integrity matters.

Attending the Class

The class is mainly structured as a series of lectures. Since the topic is a bit technical there is a lot
of material that I need to cover. That does not mean that there will not be any class discussion,
nonetheless you should perhaps expect less than what is typical in other classes. Please be in class
before the lecture starts. If, by some serious reason, you are late, enter the classroom quietly. You
are not allowed to use any computer, personal data assistant, and/or smart phone while in class.
You should, however, bring a scientific calculator that you will use to solve problems in class. Class
participation points will be awarded only based on active participation during class. Attendance
will count against participation.

Readings
The required textbook for the course is:

Hull, John, Options, Futures, and Other Derivatives, Prentice Hall, 10th edition, 2018.

I will also provide a set of lecture notes before class. The lecture notes will be also posted on the
course website. These notes are not a substitute for attending classes since the class discussion will
add value to the notes.

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Course outline
This is a tentative outline of the topics that will be covered. There might be some slight variation
due to time constraints. You are expected to read the material in the text (all chapters refer to the
required textbook, unless otherwise noted) prior the relevant lecture.

Lecture 1
Monday October 22: Introduction to Stochastic Behavior of Prices
Readings: Chapter 14 - Wiener process
Goal: How to apply a Monte Carlo simulation to price an option.

Lecture 2
Wednesday October 24: Volatility Estimation - Part I
Readings: Chapter 23 - Estimating volatilities and correlations
Goal: To understand how to calculate the volatility of an asset from
historical observations of price changes.

Lecture 3
Monday October 29: Volatility Estimation - Part II
Readings: Chapter 23 - Estimating volatilities and correlations
Goal: Introduction to GARCH technology and estimation.
Assignment: Homework 1 is due at the time of class.

Lecture 4
Wednesday October 31: Value at Risk
Readings: Chapter 22 - Value at risk
Goal: To understand how to construct a measure of worst case scenario
in a probabilistic way.

Lecture 5
Monday November 5: Implied Volatility
Readings: Chapter 19 - Volatility smiles
Goal: To understand how to extract the market estimate of future
volatility from the price of an option.
Assignment: Homework 2 is due at the time of class.

Lecture 6
Wednesday November 7: Intro to Models with Stochastic Volatility
Readings: Chapter 20 - Volatility smiles
Chapter 23 - Estimating volatilities and correlations
Goal: Introduction to option pricing with stochastic volatility.

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Lecture 7
Monday November 12: Volatility Derivatives
Readings: Chapter 26 - Exotic options
Goal: Examine various exotic derivatives.
Assignment: Homework 3 is due at the time of class.

Lecture 8
Wednesday November 14: Exam I
Reading: Study!
Goal: Do as well as you can!
Note: Please bring a scientific calculator. No food is allowed during
the exam. If you finish early, please, gather your things quickly
and exit the room quietly.

Thanksgiving Break
Wednesday November 19- No Class
21:

Lecture 9
Monday November 26: Swaps - Part I
Readings: Chapter 7 - Swaps
Goal: To understand the basic functioning of a swap contract and its
application to risk management.
Assignment: Homework 4 is due at the time of class.

Lecture 10
Wednesday November 28: Energy Derivatives
Readings: Chapter 35 - Energy and commodity derivatives
Goal: To understand the basic functioning of a swap contract and its
application to risk management.

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Lecture 11
Monday December 3: Credit Derivatives
Chapter 24 - Credit risk
Chapter 25 - Credit derivatives
Goal: To understand how a firm/investor can protect themselves from
credit risk by taking hedging against changes in the credit qual-
ity of its creditors.
Assignment: Homework 5 is due at the time of class.

Lecture 12
Wednesday December 5: Structured Finance
Readings: Chapter 8 - Securitization and the credit crisis
Goal: To understand how firms credit risk can be shared by packaging
loans into securities or more complex structures.
Assignment: Exam II is due at the time of class.

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