Change of plans for this Tuesday’s Finance 4366 class meeting

The Electric Reliability Council of Texas (AKA “ERCOT”) issued a press release earlier today (see http://www.ercot.com/news/releases/show/225151) warning of possible “rotating outages” statewide for today, Monday, and Tuesday. Rather than roll the dice that we (students and faculty alike) will all have online access on Tuesday, from 11 am – 12:15 pm, I will post a recorded lecture based on my “Properties of Stock Options” lecture note in place of a real-time, synchronous class meeting that day. This recorded lecture will be made available in the Media Gallery section of the Finance 4366 Course Canvas page sometime tomorrow.

In the meantime, if you have questions about any aspect of Finance 4366, point your device’s browser to “appointment.garven.com” and set up a Zoom appointment with me there. Given the current statewide climate event (which I have nicknamed “Icepocalypse 2021”), I figure that the odds of just two people having a successful synchronous Zoom meeting (particularly on Tuesday) are much better than the odds of a couple of dozen people doing so.

Important announcement: we will meet synchronously tomorrow via Zoom for our regularly scheduled 11-12:15 class session

Finance 4366 (Options, Futures, and Other Derivatives) will meet synchronously tomorrow via Zoom for our regularly scheduled 11-12:15 class session.  We’ll devote our attention to a (very) brief review of my recorded lecture about the replicating portfolio approach for pricing forward/futures contracts and devote most of our time to a discussion of the replicating portfolio approach for pricing call and put options.

If you haven’t already watched my recorded lecture, be sure to do so prior to tomorrow’s class; that lecture introduces the replicating portfolio approach to pricing forwards and futures, based on the lecture note at http://fin4366.garven.com/spring2021/lecture6.pdf.  Tomorrow, we will focus attention on the “Pricing Options” lecture note (at http://fin4366.garven.com/spring2021/lecture6a.pdf).

Finance 4366 Grades on Canvas

I just finished posting Finance 4366 numeric course grades to Canvas.  To date, grades have been assigned for four class meetings, two quizzes, a student survey, and one problem set. Each class attendance (absence) receives a grade of 100 (0); I assigned a grade of 100 for all surveys completed by January 21st, and these grades are included under the Problem Set category, along with the grade earned on Problem Set 1. Since we have had no exams yet, I calculated the current (February 1st) course numeric grade using the following equation:

(1) Current (February 1, 2021) Course Numeric Grade = (.10(Class Attendance) +.10(Quizzes) +.20(Problem Sets))/.4

Or course, equation (1) is a special case of the final course numeric grade equation (equation (2) below) which also appears in the course syllabus:

(2) Final Course Numeric Grade =.10(Class Attendance) +.10(Quizzes) +.20(Problem Sets) + Max{.20(Midterm Exam 1) +.20(Midterm Exam 2) +.20(Final Exam),.20(Midterm Exam 1) +.40(Final Exam),.20(Midterm Exam 2) +.40(Final Exam)}

As the spring semester progresses and I continue to collect grades in the attendance, quiz, problem set, and exam categories, then the course grade on Canvas will dynamically incorporate that information on a timely basis for each student. After I record midterm 1 grades, I will apply equation (3) below (also a special case of equation (2) above) to determine your numeric course grade at that point in time:

(3) Course Numeric Grade after Midterm 1 = (.10(Class Attendance) +.10(Quizzes) +.20(Problem Sets) +.20(Midterm 1))/.6

After I record midterm 2 grades, I will apply equation (4) below (also a special case of equation (2) above) to determine your numeric course grade at that point in time:

(4) Course Numeric Grade after Midterm 2 = (.10(Class Attendance) +.10(Quizzes) +.20(Problem Sets) +.20(Midterm 1) +.20(Midterm 2))/.8

After I record final exam grades, I will use equation (2) above to determine your final course numeric grade, and (as also noted in the course syllabus), the final course letter grade will be based upon the following schedule of final course numeric grades:

A 93-100% C 73-77%
A- 90-93% C- 70-73%
B+ 87-90% D+ 67-70%
B 83-87% D 63-67%
B- 80-83% D- 60-63%
C+ 77-80% F <60%

 

Z Table Extra Credit Assignment (due 11 a.m. CT on Tuesday, February 2)

Here’s an extra credit opportunity for Finance 4366. Working on your own (i.e., this is not a group project; credit will only be given for spreadsheets that are uniquely your own), build your own “z” table in Excel (patterned after the table located at http://fin4366.garven.com/stdnormal.pdf); the top row should have values ranging from 0.00 to 0.09, and the first column should have z values ranging from -3.0 to +3.0, in increments of 0.1).

Quite conveniently, Excel has the standard normal distribution function built right in; e.g., if you type "=normsdist(z)", Excel returns the probability associated with whatever z value that you provide. Not surprisingly, if you type "=normsdist(0)", .5 is returned since half of the area under the curve lies to the left of the expected value E(z) = 0. Similarly, if you type "=normsdist(1)", then .8413 is returned because 84.13% of the area under the curve lies to the left of z = 1. Perhaps you recall from your QBA course that 68.26% of the area under the curve lies between z = -1; this "confidence interval" of +/1 one standard deviation away from the mean (E(z)=0) is calculated in Excel with the following code: "=normsdist(1)-normsdist(-1)", and so forth.

The grade you earn on this extra credit assignment will replace your lowest quiz grade; that is if your lowest quiz grade is lower than your extra credit grade. The deadline is 11 a.m. CT on Tuesday, February 2.

You can turn your spreadsheet for this extra credit assignment in at https://baylor.instructure.com/courses/132766/assignments/1020537.

2021/2022 Department of Finance, Insurance, and Real Estate Scholarship Application

The Department of Finance, Insurance, and Real Estate is accepting scholarship applications for the 2021/2022 academic year until 5:00pm March 1, 2021. Follow the link below to access the application for all available scholarships:

2021/2022 Finance, Insurance, and Real Estate Scholarship Application

Please read the scholarship information carefully and note that you must already be admitted to the business school; you must have a declared major in Finance, Risk Management and Insurance, or Real Estate, and you must have already completed 6 hours of upper-level course work.

Calculus, Probability and Statistics, and a preview of future topics in Finance 4366

Probability and statistics, along with the basic calculus principles covered last Thursday, are foundational for the theory of pricing and managing risk with financial derivatives, which is what this course is all about. During yesterday’s class meeting, we introduced discrete and continuous probability distributions, calculated parameters such as expected value, variance, standard deviation, covariance, and correlation, and applied these concepts to measure expected returns and risks for portfolios comprising risky assets. During tomorrow’s class meeting, we will take a deeper dive into discrete and continuous probability distributions, in which the binomial and normal distributions will be showcased.

On Tuesday, February 2, we will introduce and describe the nature of financial derivatives, and motivate their study with examples of forwards, futures, and options. Derivatives are so named because they derive their values from one or more underlying assets. Underlying assets typically involve traded financial assets such as stocks, bonds, currencies, or other derivatives, but derivatives can derive value from pretty much anything. For example, the Chicago Mercantile Exchange (CME) offers exchange-traded weather futures and options contracts (see “Market Futures: Introduction To Weather Derivatives“). There are also so-called “prediction” markets in which derivatives based upon the outcome of political events are actively traded (see “Prediction Market“).

Besides introducing financial derivatives and discussing various institutional aspects of markets in which they are traded, we’ll consider various properties of forward and option contracts, since virtually all financial derivatives feature payoffs that are isomorphic to either or both schemes. For example, a futures contract is simply an exchange-traded version of a forward contract. Similarly, since swaps involve exchanges between counter-parties of payment streams over time, these instruments essentially represent a series of forward contracts. In the option space, besides traded stock options, many corporate securities feature “embedded” options; e.g., a convertible bond represents a combination of a non-convertible bond plus a call option on company stock. Similarly, when a company makes an investment, so-called “real” options to expand or abandon the investment at some future is often present.

Perhaps the most important (pre-Midterm 1) idea that we’ll introduce is the concept of a so-called “arbitrage-free” price for a financial derivative. While details will follow, the basic idea is that one can replicate the payoffs on a forward or option by forming a portfolio comprising the underlying asset and a riskless bond. This portfolio is called the “replicating” portfolio, since, by design, it replicates the payoffs on the forward or option. Since the forward or option and it’s replicating portfolio produce the same payoffs, then they must also have the same value. However, suppose the replicating portfolio (forward or option) is more expensive than the forward or option (replicating portfolio). If this occurs, then one can earn a riskless arbitrage profit by simply selling the replicating portfolio (forward or option) and buying the forward or option (replicating portfolio). However, competition will ensure that opportunities for riskless arbitrage profits vanish quickly. Thus the forward or option will be priced such that one cannot earn arbitrage profit from playing this game.

Week 2 readings, quiz, and problem set

Here’s a friendly reminder that the following readings are due tomorrow:

1. The New Religion of Risk Management, by Peter Bernstein
2. Normal and standard normal distribution, by James R. Garven
3. Mean and Variance of a Two-Asset Portfolio, by James R. Garven

Keep in mind that Quiz 2, which is based on these readings, must be completed prior to the start of class tomorrow. I have also changed the due date for Problem Set 1 from tomorrow (Tuesday, January 26) to Thursday, January 28. You should consider all other due dates listed on Canvas and on the course website as pretty much set in stone for the remainder of the semester.

Going forward, I will typically not post reminders like this concerning Finance 4366 assignment deadlines; however, you’ll be “good to go” in Finance 4366 if you faithfully follow the guidelines listed in my “How to know whether you are on track with Finance 4366 assignments” posting.

Welcome to the Spring 2021 edition of Finance 4366!

Happy new year! My name is Dr. James R. Garven, and I am your professor for the Spring 2021 edition of the Finance 4366 (Options, Futures, and Other Derivatives) course. Here are a few things to keep in mind as we head into the beginning of the Spring 2021 semester:

1. Finance 4366 will meet on Tuesday and Thursday from 11 a.m. – 12:15 p.m. via Zoom (beginning on January 19).

2. The home page for the Finance 4366 course website is at http://fin4366.garven.com, and the course syllabus is available at http://fin4366.garven.com/syllabus.pdf. Course-related documents (e.g., assigned readings, problem sets, sample exams, lecture notes, etc.) are distributed from the course website.  (Important Note: the password for gaining access to password-protected page links is listed in item 3 on the Spring 2021 Finance 4366 Canvas home page).

3. The course blog is at http://derivatives.garven.com and linked from the “Course Blog” button on the home page of the course website. I use the course blog to post important announcements and provide insights linking course topics with the “real” world. I require that all students enrolled in Finance 4366 subscribe to the course blog via email; instructions for doing so are provided here. Students may also follow the course blog on Facebook or Twitter but are not required to do so.

4. I use Canvas for scheduling class meetings, administering quizzes and exams, collecting problem sets, and posting grades.

5. Be sure to read “Required Text Materials in Finance 4366” at https://wp.me/paORhh-2c4 prior to making a textbook purchase, as the information provided there may save you some money!

6. Please complete the Finance 4366 Student Information Survey (at https://bit.ly/FIN4366survey) prior to the first day of class on January 19 so I can read up on all of your names, academic backgrounds, interests, and aspirations (similar information about me is available at http://garven.com). I count the Finance 4335 Student Information Survey as a problem set which receives a grade of 100 (if successfully completed any time between now and the second day of class on January 21), and 0 otherwise

In closing, I hope you have had a wonderful Christmas break and that you are looking forward to a happy and productive Spring 2021 semester at Baylor University (particularly in Finance 4366)!

Sincerely,

Dr. Garven

Required Text Materials in Finance 4366

The required textbook for the Options, Futures, and Other Derivatives (Finance 4366) course at Baylor University (coincidentally) shares the same title as the course. Authored by University of Toronto finance professor John Hull, the “Options, Futures and Other Derivatives” textbook is now in its 10th edition, and it is very expensive; indeed, the campus bookstore currently offers used copies for $274.25, and new copies for $365.50. Prices on Amazon are (not surprisingly) lower; e.g., as of December 10, 2020, new copies of the book offered there are listed for less than $300.

Although I list the 10th (US) edition as “required” for Finance 4366 in the course syllabus, you are welcome to rely upon earlier (typically used and considerably less expensive) editions of this book; e.g., the 8th and 9th (US and international) editions are completely acceptable substitutes, since the chapters that we cover in Finance 4366 are virtually identical across the 8th through 10th editions. Just make sure that the book author (John C. Hull) and title (Options, Futures, and Other Derivatives) are the same, that the edition of the book is no earlier than the 8th edition, and that you are buying the textbook and not the solutions manual or instructors manual.

Finally, don’t worry about whether the book you buy or rent includes the “Derivagem” software. Derivagem is an Excel spreadsheet template that you can download from the course website.