Accounting and Finance

Financial Derivatives

Module code: N1559
Level 6
15 credits in spring semester
Teaching method: Lecture, Seminar
Assessment modes: Coursework, Unseen examination

This module introduces the markets, trading and valuation of common derivative products, such as forwards/futures, swaps and options. Both equity and interest rate markets are covered.

Practical applications of derivatives for hedging or investment purposes are discussed, including their risk-return profiles, advantages and limitations. Fundamental concepts of no arbitrage and risk neutral pricing are introduced, culminating in the well known Black Scholes formula for option pricing at the end of the module.

Topics include:

  • introduction to derivative markets: forwards, futures, swaps and options: payoffs, market participants, benefits and dangers
  • equity and FX futures and forwards: markets, applications, margining and hedging
  • pricing of forwards and futures: no arbitrage, replication, basis risk
  • forward rates and forward rate agreements: term structure of interest rates
  • interest rate futures and swaps: day-count conventions, duration-based hedging
  • option markets and strategies: put-call parity, moneyness, European vs American options, price bounds, structuring, payoff decomposition
  • pricing options: the binomial tree model
  • exotic options: digital options, barrier options, Asian options
  • stochastic models for derivatives: geometric Brownian motions, Wiener processes
  • Black-Scholes Model: from binomial to Black Scholes, pricing formulae for European options, options on futures
  • Greeks: risk management with options, hedging.

Module learning outcomes

  • Describe the function of derivatives in financial markets and discuss their advantages and limitations.
  • Identify, compare and evaluate the main derivative products commonly traded in equity, foreign exchange and interest rate markets, as well as some of the more exotic instruments.
  • Explain the concept of no arbitrage and recognize the central role it places in derivatives pricing.
  • Implement the binomial tree and Black-Scholes models to find the no arbitrage price of a range of derivative securities. Critically examine and debate the key assumptions and limitations of the approaches.