… are available at http://fin4366.garven.com/spring2018/ps2solutions.pdf…
This coming Tuesday, we will complete the probability and statistics tutorial by studying the binomial and normal probability distributions. On Thursday, we introduce financial derivatives, relying upon a combination of textbook chapters and teaching notes that I have authored. We will begin by defining financial derivatives and motivating their study with examples of forwards, futures, and options. Derivatives are so named because the prices of these instruments are derived from the prices of one or more underlying assets. The types of underlying assets upon which derivatives are based are often traded financial assets such as stocks, bonds, currencies, or other derivatives, but they can be pretty much anything. For example, the Chicago Mercantile Exchange (CME) offers exchange-traded weather futures contracts and options on such 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 Markets“).
Besides introducing 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 of these 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 there are also embedded options in corporate securities; 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, there may be embedded “real” options to expand or abandon the investment at some future date.
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 consisting of the underlying asset and a riskless bond. This portfolio is called the “replicating” portfolio, since it is designed to perfectly replicate the payoffs on the forward or option. Since the forward or option and its 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). It 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 very quickly. Thus the forward or option will be priced such that one cannot earn arbitrage profit from playing this game.
… are available at http://fin4366.garven.com/spring2018/ps1solutions.pdf.
Since Baylor University is closed today as a result of today’s “Icepocalypse”, I have updated the Spring 2018 Finance 4366 Course Schedule accordingly. The net effect of today’s class cancellation is that the schedule for the remainder of the semester has been shifted forward; consequently, Problem Set 1 is now due on Thursday, January 18 (instead of today), and the two midterm exams will now take place on Thursday, February 15 and Tuesday, April 3 (instead of 2/13 and 3/29). Thursday’s class will begin with a quiz based upon the assigned readings for our statistics tutorial. The readings, problem sets, and lecture notes pages have also been updated to reflect the fact that Finance 4366 is now officially scheduled to meet 29 rather than 30 times during the Spring 2018 semester.
I have decided to offer the following extra credit opportunity for Finance 4366. You can earn extra credit by attending and reporting on Dr. Richard Vedder’s upcoming lecture entitled “Can Markets Improve College Education and Make it More Affordable”:
Thursday, January 18
Foster 250 @ 4:00 pm
Richard Vedder: Distinguished Professor of Economics at Ohio University // Adjunct Scholar at American Enterprise Institute
Talk Title: “Can Markets Improve College Education and Make it More Affordable”
If you decide to take advantage of this opportunity, I will use the grade you earn to replace your lowest quiz grade in Finance 4366 (assuming that your grade on the extra credit is higher than your lowest quiz grade). The report should be in the form of a 1-2 page executive summary in which you provide a critical analysis of Dr. Vedder’s lecture. In order to receive credit, the report must be submitted via email to email@example.com in either Word or PDF formats by no later than Monday, January 22 at 5 p.m.
At any given point in time during the upcoming semester, you can ensure that you are on track with Finance 4366 assignments by monitoring due dates which are published on the course website. See http://fin4366.garven.com/readings/ for due dates pertaining to reading assignments, and http://fin4366.garven.com/problem-sets/ for due dates pertaining to problem sets. Also keep in mind that short quizzes will be administered in class on each of the dates indicated for required readings. As a case in point, since the required readings entitled “Optimization” and ” How long does it take to double (triple/quadruple/n-tuple) your money?” are listed for Thursday, January 11, this means that a quiz based upon these readings will be given in class on that day.
Important assignments due on the second class meeting of Finance 4366 (scheduled for Thursday, January 11) include: 1) filling out and emailing the student information form as a file attachment to firstname.lastname@example.org, 2) subscribing to the Wall Street Journal, and 3) subscribing to the course blog. A completed Student information form is graded as a problem set and receives 100 points; if you don’t turn in a Student information form, then you will receive a 0 for this “problem set”. Furthermore, tasks 2 and 3 listed above count toward your class participation grade in Finance 4366.
Allow me to introduce you to the graduate assistant for Finance 4366. Alexander Law is an MSECO student, and his email address is Alexander_Law@baylor.edu.
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 quite expensive; on Amazon, it costs around $230 to purchase, and around $77 to rent.
An important marketing “scheme” (or less charitably, “scam”) in the world of textbook publishing involves frequently publishing “new” editions of textbooks. Often, new editions are not all that different from earlier editions. This is certainly the case with Hull’s textbook. For example, I found that by comparing chapter titles and numbers in tables of contents for the 9th and 10th editions, the 10th edition has a new ninth chapter that I would not cover anyway; furthermore, two chapter titles were slightly renamed but chapter contents in both cases remain completely unchanged.
Although I list the 10th (US) edition as “required” for Finance 4366 in the course syllabus, you are welcome to rely upon earlier (and considerably less expensive) editions of this book; e.g., the 7th, 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 7th through 10th editions. For example, if you go to http://www.ebay.com/bhp/options-futures-and-other-derivatives, you will find an array of various editions of Hull’s textbooks ranging in price from $3.62 to $35.99 (make sure you are buying the textbook, not the solutions manual). Perhaps you may be able to find even better deals elsewhere; just make sure that the book author (John C. Hull) and title (Options, Futures, and Other Derivatives) are the same, and that the edition of the book is no earlier than the 7th edition.
Finally, don’t worry about whether the book you buy has the CD; the software on the CD (called “Derivagem”) is a rather simple Excel spreadsheet which you can download directly from Hull”‘s website at the following address: http://www.rotman.utoronto.ca/~hull/software/DG200.01.xls.
A course blog has been established for Finance 4366 at the address http://derivatives.garven.com; it is also linked from the “Course Blog” button located on the course website. I recommend that you follow the options, futures, and other derivatives course blog regularly via email, RSS, Facebook, and/or Twitter.
The options, futures, and other derivatives course blog provides me with a convenient means for distributing important announcements to the class. Topics covered on the course blog typically include things like changes in the course schedule, clarifications and hints concerning problem sets, information about upcoming exams, announcements concerning extra credit opportunities, and short blurbs showing how current events relate to many of the topics which we cover in Finance 4366.
If you already are familiar with RSS, this is a great way to subscribe to the options, futures, and other derivatives course blog. By going to the http://derivatives.garven.com/feed webpage, you can subscribe by using Firefox’s Live Bookmarks feature, Internet Explorer’s RSS feed subscription feature, or an RSS reader. If you are either a Facebook or Twitter user, everything that is posted on the options, futures, and other derivatives course blog is automatically posted to Facebook and “tweeted”, so you can also subscribe by “liking” the Finance 4366 Facebook page or by “following” @fin4366 on Twitter. Finally, you can also subscribe via email. The remainder of this blog entry explains how to subscribe to the options, futures, and other derivatives course blog via email.
Email Subscription Instructions:
Email Subscription Instructions: If you would like to receive the risk management course blog via email, you can do this by going to http://derivatives.garven.com and entering your email address in the form provided on the right hand side of that webpage:
After clicking “Subscribe”, the following information will appear on your screen:
Next, check for an email from “Options, Futures, and Other Derivatives <email@example.com>”:
Next, simply click the “Confirm Follow” button. This will cause you to receive the following email:
From that point forward, whenever I post to the course blog, you will immediately receive a nicely formatted version of the blog posting via email. Also, you can opt to change your delivery preferences, or even cancel your subscription.