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DERIVATIVES

ISB&M, Kolkata Campus Trimester V, Batch of 2010-12

Instructor(s): Debarghya Bagchi (e-mail: debarghya.bagchi@isbmk.edu.in; Tel.: 033-66131627) Surendra Poddar (e-mail: surendra.poddar@isbmk.edu.in; Tel.: 033-66131619) Lectures: Schedule to be announced soon Office Hours: Monday to Saturday, 9:00 18:00 pm, other hours by appointment Credits: 3 Course Description and Objectives

This course presents and analyzes derivatives, such as forwards, futures, swaps, and options. These instruments have become extremely popular investment tools over the past 30 years, as they allow one to tailor the amount and kind of risk one takes, be it risk associated with changes in interest rates, exchange rates, stock prices, commodity prices, inflation, etc. They are used by institutions as well as investors, sometimes to hedge (reduce) unwanted risks, sometimes to take on additional risk motivated by views regarding future market movements. The course defines the main kind of derivatives, shows how they are used to achieve various hedging and speculating objectives, introduces a framework for pricing derivatives, and studies several applications of derivative-pricing techniques outside derivative markets. NB By necessity, the course will often be technical and involve a fair amount of quantitative and abstract analysis. I expect the average student to find it challenging.
Pedagogy

The pedagogy followed for the course will be a mix of discussions, case studies and lectures. You will be informed of any change in schedule in advance.
Course Outline

Sessions 1 2: Introduction to Derivatives


Pre-session Reading Classroom Session Learning Outcome

Options, Futures, and other Derivatives Hull & Basu Rationale of Derivatives Concept of Financial Risk Current Scenario of Derivatives Market Understand the need & utility of derivatives Understanding of current scenario of Derivatives Markets

Pgs. 1-23

Session 3: Forward Contracts


Pre-session Reading Classroom Session Learning Outcome

Options, Futures, and other Derivatives Hull & Basu Introduction to Forward Contracts

Pgs. 3-6, 97-99

Forward Rate Agreement (FRA)


Conceptual clarity regarding Forward Contracts & FRA

Sessions 4 6: Futures Contract


Pre-session Reading

Options, Futures, and other Derivatives Hull & Basu Introduction to Futures Contracts

Pgs. 25-82

Classroom Session

Indian Perspective Futures Payoff Futures for hedging, speculation & Arbitrage Pricing Markets & Mechanism Legal Environment
Conceptual clarity regarding all aspects of Futures Contracts

Learning Outcome

Sessions 7 9: Options Contracts


Pre-session Reading

Options, Futures, and other Derivatives Hull & Basu Basics of Options Contracts

Pgs. 197-219

Classroom Session

Indian Perspective Options Payoff Options for hedging, speculation & Arbitrage Factors determining Options Value
Conceptual clarity regarding all aspects of Options Contracts and their practical usage

Learning Outcome

Sessions 10 11: Options Pricing


Pre-session Reading Pgs. 257-278, 297-324

Options, Futures, and other Derivatives Hull & Basu Binomial Trees The Black Scholes Model Upper & Lower Bounds for Options Prices Stochastic models

Classroom Session Learning Outcome

Conceptual clarity on Options Pricing

Sessions 12 13: Options Trading Strategies


Pre-session Reading Classroom Session

Options, Futures, and other Derivatives Hull & Basu Strategies involving a single option and a stock Spreads Combinations Other Payoffs Game on Options Trading Strategies

Pgs. 239-255

Assignment Learning Outcome

Conceptual clarity on Options Trading Strategies

Session 14: The Greeks


Pre-session Reading

Options, Futures, and other Derivatives Hull & Basu Naked and covered positions Stoploss strategy Theta Gamma Relationship between Delta, Theta and Gamma Vega Rho Hedging in practice Delta Neutral Hedging Conceptual clarity on the Greeks

Pgs. 367-396

Classroom Session

Learning Outcome

Session 15: Interest Rate Futures


Pre-session Reading

Options, Futures, and other Derivatives Hull & Basu Interest rate futures

Pgs. 143-160

Classroom Session Learning Outcome

Treasury bond futures Eurodollar futures Duration Duration basedhedging strategies Conceptual clarity on Interest Rate Futures

Sessions 16 17: Credit Derivatives


Pre-session Reading Classroom Session Learning Outcome

Options, Futures, and other Derivatives Hull & Basu

Pgs. 535-564

Credit Default Swaps


CDS forwards and options

Asset Backed Securities Conceptual clarity on Credit Derivatives

Session 18: VaR

Pre-session Reading Classroom Session Learning Outcome

Options, Futures, and other Derivatives Hull & Basu

Pgs. 461-485

The VaR measure


Application of VaR

Conceptual clarity on VaR

Sessions 19 20: Estimating Volatilities and Correlations, Volatility Smiles


Pre-session Reading Classroom Session Learning Outcome

Options, Futures, and other Derivatives Hull & Basu

Pgs. 487-503

Estimating Volatilities & Correlations


Volatility Smiles

Conceptual clarity on Estimating Volatilities and Correlations, Volatility Smiles

Evaluation Criteria

Quizzes Assignment NCFM Derivatives Markets (Dealers) Module NCFM Options Trading Strategies Module Mid Term Exam End Term Exam
Reading Material & Reference

20% 10% 25% 10% 15% 20%

Options, Futures, and Other Derivatives Hull and Basu Investment Science D. Luernburger

ADDITIONAL INFORMATION Grading Points will be assigned to each graded assignment, quiz, class activity, and exam. To receive full credit for problems done on any graded activity, you must show sufficient work in a clear, logical, and organized manner. It helps me determine where your error is (hence, you might be able to obtain partial credit) and if you are logically applying the tools learned to solve the given problem. Your work must be neat and organized. "Messy" and/or disorganized work will not be accepted. Absences It is your responsibility to attend every class meeting. If you are absent frequently or for an extended period of time, contact the instructor / Academic Coordinator as soon as possible to discuss your situation. Absences and tardiness to class can have a negative impact on your success in this course. Two or more absences (including supplemental sessions) may result in an automatic F grade, especially if the student is not keeping up with his or her assignments and study plan.

Calculator Calculators are not allowed for tests. Calculator use is allowed for homework problems where needed.

Cell Phones Please put your cell phone on silent mode or turn it off prior to the start of the class so that it does not disturb the class session.

Academic Honesty All quizzes and exams are closed books (unless otherwise mentioned) and must be done by your individual effort. You may not consult with any classmates while taking quizzes or exams. You are not allowed to tell a friend the type of questions on the quiz or exam, the answers, or help a classmate in any way (e.g. by explaining how to solve the problem). This would fall under the guidelines of academic integrity and any evidence of cheating will result in a score of 0 for all parties involved. Also keep in mind that we are assessing your knowledge and understanding of the concepts and strategies attempting to find the answers online or through other sources is not in the spirit of academic honesty. You must complete all assignments. You may consult with the instructor or with the online help aids. However, you are not allowed to let someone else do your assignment for you. This would fall under the guidelines of cheating. An F will be assigned to students involved in cheating and will be reported to the Academic Chairperson.

Disruptive Behavior Disruptive Behavior leads to a loss of learning time. Examples of disruptive behavior are activated beepers and cell phones, texting messages, making offensive remarks, packing books before class is over, making excessive noise, leaving class early, coming to class late, sleeping in class, prolonged chattering, reading other materials not relevant to this class, etc. If a student takes part in disruptive behavior, the instructor reserves the right to exclude the student immediately from the class meeting, and will be marked absent.

Dont Procrastinate Derivatives is not a subject that you can consistently be successful in by "cramming" a day or two before the test. By "cramming" you don't develop proficiency in doing the problems, knowledge of what to do on a particular problem and long-term understanding of the process. Also, if you procrastinate, you may fall so hopelessly behind that it becomes impossible to complete the course by the end of the trimester. It requires constant work to keep on top of the material.

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