|The 2007 – 2009 financial crisis highlighted once again the key role that financial derivatives play in modern financial markets. As the financial world becomes increasingly more complex and the opportunities offered by derivative instruments increase, so do the potential risks from their misunderstanding and misuse. As the global derivatives market keeps increasing – it reached $600 trillion (notional) in December 2010, a 40% increase over its value in December 2006 – it is as important as ever to understand both the strategic opportunities offered by derivative instruments, as well as the risks they imply.
This course develops the theory of derivative security pricing and their applications. We cover both simple linear derivative contracts, such as forward, futures, and swaps, as well as more complex non-linear derivatives, such as put and call options. The focus of the course is on the pricing and hedging of derivative securities through the principles of no-arbitrage. These concepts are then applied to dynamic trading models, through the development of the binomial tree model, and the Black-Scholes model. We discuss several important applications of the pricing methodology, such as its implications for risk management, exotic options, the pricing of corporate securities (corporate bonds, callable bonds, equity, etc.), and real options for investment decisions.