(April 18) (1) On Monday, we will review the latest homework assignment no. 10 and continue with our discussion of the "greeks".  Following that, we will discuss option replication and arbitrage.   We will also discuss American option pricing and conditions for early exercise.  With the remaining time, we will discuss the pricing of currency and futures options. (2) The final exam will be distributed at the end of class and due no later than the following Monday.
	(April 11) (1) Homework 10 is now posted.  Please note that you will need to obtain market information regarding various options as of the close of trading on Tuesday, April 17. (2) When we next meet on Monday, we will continue our discussion of options.  We will discuss historical and implied volatility, along with the volatility smile.  We will also discuss how to make adjustments to pricing models to accommodate dividends, both discrete and continuously paid dividends.  We will then discuss the "greeks", which refer to the various sensitivities of option prices to the model's various inputs, and discuss their uses for risk management. (3) Please remember to bring to class your prior option handouts.
	(April 6) On Monday, we will continue with our discussion of options.  We will discuss boundary conditions and delve into various pricing models including the binomial and Black-Scholes models.  Please remember to bring your option handouts to class.
	(March 29) (1) Homework 9 is now posted and is due on Monday, April 16.  You will need to obtain market information related to trading conducted on Monday, April 9. (2) On Monday, we will conclude our discussion of swaps and then move into options.  Initially, we will look at option payoff diagrams and associated strategies, look at how to read price quotations and option chains, and discuss other institutional arrangements.  Following that, we will use the remaining time to considering various valuation models including Black-Scholes, and we will also explore issues regarding obtaining inputs to the Black-Scholes model. (3) Please familiar yourself with the 888option.com website and how to read an option quote and option chain.  To practice, go to the website, click "Quote", then enter a stock symbol and click "Go."  Then click and look around to see the variety of information presented. (3) Finally, please remember to bring your option handout from last class and be sure to check that your Option! software is fully functional.  If you purchased the 5th edition of the textbook, you will find the software on the Blackwell website at "www.blackwellpublishing.com/kolb" under "Downloads".  Alternatively, prior editions came with a disk.  In either case, be sure it is operational now!.
	(March 15) (1) Homework 8 is now posted.  Please note that it is not due until Monday, April 2.  Also, you will need to obtain a variety of market information related to trading as of Monday, March 26.  (2) On Monday, we will spend the entire class time discussing swaps.  We will discuss institutional dimensions of the market as well as how to both price and value a swap.  The initial focus will be on interest rate swaps.  As time permits, we will also get into bootstrapping techniques for constructing the zero discount curve.  Discussion of currency and commodity swaps pricing will be in a subsequent class. (3) I will email you a teaching note on "The Pricing and Valuation of Swaps" that you should read carefully before coming to class.  (This can also be found in Chapter 28 of Financial Derivatives: Pricing and Risk Management, Kolb and Overdahl, editors, Wiley, 2010.)  I will also email you a copy of the *SWAP* software that you can also find posted under Syllabus/Readings.  Please be sure that your *SWAP* software is fully operational and you have carefully reviewed and turned on the appropriate "system requirements" including add-ins and enabling macros.
	(March 6) On Monday, March 6, we will conclude our discussion of equity futures with particular focus on single stock futures.  With the remaining time, we will discuss currency futures and forwards including their valuation, institutional arrangements, and application.  At the conclusion of class I will distribute the mid-term exam, which will be due the following Monday, March 19.
	(February 22) (1) Homework 7 is now posted.  Please note that you will need to obtain a variety of market information related to trading as of Tuesday, March 6.  Further directions are provided on the assignment. (2) On Monday, March 5 we will continue our discussion of stock index and single stock futures.  We will focus on how market professionals use these products in both active and passive strategies.  We will also discuss institutional issues such as performance bonds and circuit breakers. (3) To prepare for class and to help you with the homework assignment, please read before coming to class pages 13-14 of the "Scams, Scoundrels and Scapegoats …" article (see the section titled "War Stories"), which can be found under the Syllabus/Readings link of the course website. (4) Please remember to bring with you the main (big) handout  from our last class. (5) Mini-lecture 5: Please study the following illustration to convince yourself that the argument holds. Assume that you are in a world with the following current market conditions: S (a stock or stock index) = $100; L (Libor) = 6%; d (div yield) = 2%; and you have a 1 year (360-day) investment horizon.  Thus, based on this information, we know that the one-year futures price should be: F =  S*[1 + (L-d)*(T-t)/360] F = 100*[1 + (.06-.02)*360/360] = 104 Now, consider the following two investment strategies, which I argue are equivalent or that you would be indifferent between choosing: 1.  Invest $100 in the stock, or 2.  Invest $100 in a money market account and go long one futures based on that stock (at 104). Scenario A: Suppose that after 1 year the stock is now at $120.  Your ending wealth from each of the two strategies are: 1.  Wealth = 120 + .02*100 = 122 (stock value plus dividends received) 2.  Wealth = 100*(1+.06) + (120-104) = 106 + 16 = 122 (money market investment plus gain on the futures) Therefore, both strategies produce the same terminal wealth. Scenario B: Suppose that after 1 year the stock is now at $80.  Your ending wealth from each of the two strategies are: 1.  Wealth = 80 + .02*100 = 82 (stock value plus dividends received) 2.  Wealth = 100*(1+.06) + (80-104) = 106 -24 = 82 (money market investment plus loss on futures) Again, both strategies produce the identical ending wealth.
	(February 14) (1) Assignment No. 6 is now posted.  Please note that you will need to obtain market information as of the close of trading on Tuesday, February 21, which can be obtained from Wednesday's WSJ and WSJ-online sources, and the CME website. (2) On Monday, we return, we will conclude for now our discussion of interest rate risk management, which we will resume at a later date when we will discuss interest rate swaps.  During the remaining time in class, we will begin our discussion of stock index and single stock futures, with our initial focus being on institutional details, valuation, and hedging.  Please be sure to read in advance the assignment reading in Chapters 7 and 8 of your text.
	(February 7) (1) Assignment No. 5 is now posted.  Please note that you will need market information as of the close of trading on Tuesday, February 14, obtained from among various sources, the WSJ, WSJ online, and the cmegroup.com website. (2) On Monday, we will continue our discussion of interest rate risk management (with futures) by also exploring immunization strategies.  We will look at the use of derivatives in facilitating both "planning period" and "asset-liability" forms of immunization. (3) During class we will also look at a case study of the events surrounding the so-called derivatives "debacle" involving the firm Metellgesselschaft ("MG").  I will email you a couple of related handouts to this case that you should review prior to coming to class so that you will be better prepared to discuss.  The MG case will nicely reinforce and tie together several concepts that we have considered recently in class including the merits of a stack versus strip hedging strategy; the issue of backwardation versus contango in futures prices; margins; and the considerations that firms should give to margining and liquidity maintenance when conducting a hedging program.
	(February 2) (1) Assignment No. 4 is now posted and will be due on Monday, February 13.  Please note that you will need market information as of the close of trading on Tuesday, February 7 best obtained by going to the indicated site after Tuesday's close for corporate bond prices, and then accessing Wednesday's February 8 online WSJ and/or the cmegroup.com website for your Tuesday futures prices. (2) In our next class, we will study the hedging of interest rate risk.  We will begin by discussing the construction of synthetic fixed rate and floating rate loans using futures (with some mention of how you similarly may hedge using swaps, caps, and forward rate agreements).  In doing so, we will examine the merits of stack versus strip hedging strategies.  These examples will then provide a nice lead-in to our exploration of more involved hedging situations in which we will introduce models that involve duration.  To help you prepare for class, please read in advance of class and pay particular close attention to the examples and material on pages 211-217 and 219-229 of your text (or equivalent pages if you are using an older edition of the text). (3) Since we discuss and utilize Libor rates and Eurodollar futures quite often in class, a nice website for reading more about how the Libor market and system works can be found at www.bbalibor.com.  You can also obtain at that site Excel spreadsheets containing historical daily Libor rate information. Recall that the underlying "asset" of the Eurodollar futures is actually the rate on a $1 million 3-month Eurodollar time deposit, which you can think of as the 3-month or 90-day Libor rate.  However, rather than quote prices in terms of a rate or yield, the exchange uses a convention called the IMM Index.  That is, the futures price is quoted in terms of a number that is equal to 100 minus the 3-month Libor rate.  Thus, if you observed a Eurodollar futures quoted at 96.00, then this corresponds to a 3-month Libor rate or yield of 100.00 - 96.00 = 4.00%.  Similarly a quote of 97.12 would correspond to a rate of 100 - 97.12 = 2.88%.  (For more discussion, see pages 152-154 of your text or look in the index for Eurodollar futures.) (4) Mini-lecture 4: Understanding interest rate futures quotes Convince yourself that the following price relations indeed hold-- a.  For the T-bond, 10-year T-note, and 5-year T-note futures contracts (which each has a notional dollar contract size of $100,000), the dollar value of a 1/32nd change in the futures price is $31.25.  To illustrate, assume that the reported futures price quote changes from say 104-160 to 104-170; the contract then has changed in value by $31.25. b.  For the 2-year T-note, the change in value is $62.50 because the notional size of the contract is $200,000 as compared to $100,000 for the earlier three contracts. c.  For the Eurodollar futures (which has a $1mm notional dollar contract size), a 1 basis point change translates to a change in price of $25.  In other words, if the futures price changes from say 95.00 to either 95.01 or 94.99 (which means a change in yield from 5.00% to either 4.99% or 5.01%),  the change in value of a contract is $25 (positive or negative depending on whether the position is held long or short, respectively).  For this reason, we refer to the Eurodollar futures as having a DV01 (i.e., the "Dollar Value of a 1 basis point change") equal to $25.  Also, corresponding to this, the Modified duration of the Eurodollar futures is .25.  To see this note that $25 = MD x 0.0001 x $1mm; thus MD must equal .25.
	(January 24) (1) Assignment 3 is now posted (due Monday, February 6).  Please note that you will need to obtain various pieces of market information as of the close of trading on Tuesday, January 31.  You can get these by going, per the instructions, to the exchange website, WSJ, and/or WSJ-online. In preparation for our next class, please visit in advance of class these various websites indicated on your homework 3 assignment and be familiar with how to read and interpret prices for the referenced interest rate futures (specifically, the Eurodollar futures, and the T-bond, 10-year T-note, 5-year T-note, and 2-year T-note futures contracts). (2) In our next class, we will begin by finishing our discussion of how margins and daily resettlement of futures contracts contributes to the financial integrity of clearing houses and futures exchanges.  We will discuss an important role (in addition to hedging) that futures markets fulfill--facilitating price discovery.  We will explore what is price discovery, how futures prices are used commercially for price-basing and improving resource allocation and decision-making, and whether there is a government interest in protecting markets against manipulation.  We will introduce the concepts of backwardation and contango, and discuss the implications of these terms for futures prices. Following this, we will review forward rate estimation, using both bond yield and money market conventions.  We will then review contract specs for several of the interest rate futures that we will be using throughout the term (including those for Eurodollars, T-notes, and T-bonds) and begin developing an understanding of their cash market linkages. (3) Mini-lectures 1, 2, and 3 Below are a few mini-lectures to clarify concepts used in class. (1) LIBOR:  First, a brief note about performing calculations with LIBOR interest rates: To determine interest amounts, we will follow standard market practice.  Libor uses an actual/360 day count convention, and interest is computed using a "simple" or "add-on" interest method. For example, if you were to borrow $1mm today and were to replay the loan in 18 days based on a stated Libor rate of 4%, the amount you would repay is computed as $1,000,000*(1+L*days/360) or $1,000,000*(1+.04*18/360)=$1,002,000. (2) Volume versus Open Interest: For clarification and your future reference, here is a short summary explanation to help clarify the difference between Volume and Open Interest as relates to futures trading. Volume is a measure of the number of contracts traded during some specified trading interval, e.g., a trading session, a day, a month, and so on. Open interest is the number of contracts currently open and outstanding.  Volume is related to open interest, but a change in volume can result in an increase, decrease, or leave unchanged open interest. Consider the following example: Assume that there are 3 traders: x, y, and z.  The traders are all trading say the March 2013 natural gas futures, which just today assume has been listed for trading for the first time.  Thus, volume for the day is initially zero and open interest is also zero since the contract heretofore has never traded. Trader x sells 1 contract to y, the long.  Volume is 1 and open interest is 1. Trader x next sells 1 contract to z, the long party to this second contract.  Volume for the day is 2 and open interest is also 2.  Note that x is now short 2 contracts while both y and z are long 1 contract each. Trader y sells 1 contract to z.  Volume is now 3 and open interest remains at 2.  Note that z is now long 2 contracts and that y has exited the market.  Trader x is still short 2 contracts. Trader z sells 2 contracts to x.  Volume for the day is 5 and open interest is zero as there are now no open contracts. (3) "Production follows Sales":  We spoke in class about one strategic response to ongoing currency risk that many firms follow in which they locate operations close to the point of sale.  To illustrate how this reduces cash flow volatility, consider the following simple example. Assume a U.S. company has annual sales in Mexico in the amount of 100 pesos.  Manufacturing is done in the U.S. where cost of goods sold is $9.  The exchange rate is currently 0.1$/peso, but could fluctuate between .08 and 1.20$/peso.  Thus, expected $ revenues are $10 and profit (net cash flow) is $10 - $9 or $1.   However, if the dollar strengthens to say 0.08$/peso, $revenues fall to $8 and profit is now a loss of $1.  Similarly, if the dollar weakens to say 1.20 $/peso, $revenues increase to $12 and profit is $3.  In sum, profits are expected to be $1, but could range between -$1 and +$3. Now assume the company produces instead in Mexico.  Cost of goods sold is thus 90 pesos (=$9/.1) and profit is 10 pesos (100 - 90) before conversion to dollars.  $ profits are expected to still be $1 (10*0.1), but could vary between +$0.80 and +$1.20 (calculated as 10*0.08 and 10*1.20).  While the expected profit (net cash flow) remains the same at $1, its volatility due to exchange rate movements has been reduced.
	(January 11) (1) As a reminder, assignment/Homework No. 2 is posted for you to look over prior to next class (it is the same that was distributed to you in class on Monday evening).  Please make a note to yourself that to get data for the assignment, you will need to access market information available at the on-line WSJ (see wsj.com, and click on 'Market Data Center' on the right side of the page or can also be found under the 'Markets' link towards the top center of the page) reflecting trading on Tuesday, January 24.  WSJ website should be updated sometime late Tuesday or early Wednesday to reflect this information. (2) To briefly recap our first lecture, we began by introducing an economic framework for analyzing whether a firm's engagement in financial risk management is justifiable from the perspective of its shareholders.  Potential channels that we identified through which risk management can enhance firm value included "numerator effects" such as the reduction of expected bankruptcy, financial distress, and related business disruption costs; the reduction of underinvestment and adverse selection problems; and the reduction of taxes.  We also discussed "denominator" effects such as the potential of risk management to have an effect on a firm's cost of capital.  Finally, we also discussed the role of executive compensation and ownership structure on the incentives to engage in risk management. Following this, we introduced a working definition of a derivative, considered a number of common derivative structures, and identified their market venue (both OTC and exchange-trade instruments).  In addition, we looked at recent BIS statistics regarding market size, including breakdowns according to product and instrument type, and by currency and maturity. We also discussed an early and seminal application of hedging, the Salomon Brothers/Merrill Lynch underwriting of an IBM debt offering and the accompanying T-bond futures hedge that was used to control the interest rate risk inherent in the offering.  In the course of doing so, we did some risk analysis and applied a couple of commonly used measures often used in fixed income analysis such as duration and DV01 (the dollar value of a 1 basis point interest rate movement). (3) At our next class, regarding homework no. 1, I look forward to hearing your summaries of firms' risk management practices, their specific uses of derivatives, and most importantly your thoughts rationalizing or disapproving of their risk management practices based on the above economic rationales. Also, in our next class, we will continue with the "why" of risk management during which we will discuss various alternatives and substitutes for reducing the demand for derivatives.  Included will be a discussion of the importance of identifying natural hedges.  Then, as we transition to the "how" of risk management, we will develop a understanding of the institutional environment for derivatives including their regulatory framework, documentation, margining and daily resettlement, and reporting conventions.  We will continue with our discussion of the two derivative building blocks: the futures/forward contract and the option contract.  We will discuss similarities and differences between futures and forward contracts.  We will cover reading and interpreting futures price quotes and related terms of trade.  We will conclude by discussing concepts related to the valuation of futures and forward contracts.
	(January 3)

Welcome all to FI 8200 "Derivative Markets"!

I hope that you will find this class to be a superb experience and I am looking forward to seeing each of you at the first class on Monday, January 9.   As a reminder, our class meets in Room 324-Aderhold Learning Center at 4:30pm.

Please check back here for updates.  Also, I will be communicating with you through your student.gsu.edu email account so please get in the habit of regularly checking it.  (If you prefer to receive your messages at another email address, please link your gsu student address to it as this is the only email address that is officially recognized by the university for communication to students.)

In the meantime, please continue to enjoy your break.  But as you find time I would encourage you to get a jump on the course.  Following our first class, we will have a 2 week break before resuming the class.  This will give you plenty of time to get caught up with things.  In the meantime, you should feel free to begin reading and reviewing course materials as well as starting on Assignment No. 1.  

Please do the following prior to the first day of class:
(1) Review and download the Spring 2012 syllabus (see the "Syllabus/Readings" link)

(2) Pick up your textbook from a bookstore or online.  The ISBN number is 978-1-4051-5049-1.  This is the latest edition, but any used/older edition will also work fine.

(3) Review the assigned chapters for the first day of class (January 9).

Prior to the January 23 class, you should also:

(4) Install your Option! software.  If you are buying the 5th edition, you will find it on the Blackwell website at "www.blackwellpublishing.com/kolb" under "Downloads".  Alternatively, prior editions came with a disk.  In either case, be sure it is operational now!

(5) Go to www.cmegroup.com, click on "Education", and you will see a set of tutorials/presentations that provide a nice introduction to derivatives, exchanges, and futures.  You may have to register to login the first time, but it is very quick and will give you access to a lot of valuable information.  At a minimum please take time to watch the following two videos. 

(i) Thirty Minutes on Futures:
http://www.cmegroup.com/education/interactive/webinars-archived/thirty-minutes-on-futures.html

(ii) Managing Risk at CME Group - How it All Works:
http://www.cmegroup.com/education/managing-risk-cme-group-how-it-works.html

(6) Begin reading the first three articles that are posted under the Syllabus/Readings link.

 

I will bring a copy to the first class but note that Assignment No. 1 is now posted under "Assignments" and is due on the second class of January 23.  You should find Question A to be a simple review based on material covered in FI 8000.  Still, I will distribute a nice review article during the first class on the topic of duration and convexity for your reference.  Question B will draw from material from our first night lecture and the articles mentioned above which I have asked you to look at.

Assignment No. 2 is also posted and will be due on the third class date of January 30.

Here is a brief summary of what we will discuss at our first lecture:
We will begin by developing a working definition of a derivative, and then consider a number of common derivative structures as well as identify their market venue (both OTC and exchange-traded instruments).  We will look at some just released statistics regarding global market size, including breakdowns according to product and instrument type, and maturity.

Then, to motivate the need for financial risk management, we will review an early case study regarding the use of financial futures for hedging--the Salomon Bros/Merrill Lynch underwriting of IBM's first public debt offering.

We will subsequently explore the "why" of financial risk management in which we examine the various channels through which financial risk management can potentially enhance shareholder value.  We will discuss how and under what conditions hedging can reduce financial distress and related business disruption costs, reduce under-investment incentives and adverse selection problems, and reduce taxes.  See all on Monday, January 9!