INSTITUTE OF BUSINESS ADMINISTRATION COURSE OUTLINE FINANCIAL DERIVATIVES Semester: Fall 2011 Instructor: Sana Tauseef Email: sasghar@iba.edu.

com Counseling Hours: Saturdays 3:30-6:00 p.m. COURSE DESCRIPTION:

The course is intended to provide the students with a strong knowledge of derivative securities (forwards, futures, options, and swaps) and the use of these securities to manage the price risk. Students taking the course must have a solid understanding of the concepts in several fields, namely, finance and economics.

SESSION
1 2

DISCUSSION TOPIC
Introduction
Introduction to risk and the basic Derivatives Instruments: Forwards, Futures, and Options. Hedging, Speculation and Arbitrage. Derivatives Market in Pakistan.

CHAPTER
1
Handout

Introduction to Futures
3 4 5 Margin Requirements; Marking to Market Normal Backwardation and Contango Orders and Position Limits. Regulations governing Cash-Settled Future Contracts (KSE Regulations)

2
Handout

Forward and Future Prices

6 7 8 9 Forward prices for Investment Assets Forward Exchange Rates Forward Commodity Prices. Forward Interest Rates; Forward Rate Agreements

5,4

Risk Management with Future Contracts

10 Should the firms hedge their risk? Basis and Spread

11 12

Hedge Ratio; Index Futures; Beta Adjustment Rolling the Hedge Forward. Case Presentation

Risk Management with Swaps

13 14 15 Interest Rate Swaps Currency Swaps Credit Default Swaps. Articles Presentation: Did Deregulated Derivatives cause the Financial Crises?

7
21

Introduction to Options
16 17 Features of Stock Options; Concept of Moneyness Intrinsic Value and Time Value. Case Presentation

Option Pricing
18 19 20 Factors affecting the Option Prices Pricing Restrictions for Options: upper and Lower Bounds Call-Put Parity. Case Presentation

Option Strategies and Profit Diagrams

21 22 23 Spreads Combinations Profit Diagrams for Option Strategies. Case Presentation Binomial Option Pricing Model Risk Neutrality; One-Period Binomial Option Pricing Model Two-Period Binomial Option Pricing Model

10

11

24 25

Continuous Time Option Pricing Model

26 27 Assumptions Behind the Black-Scholes Option Pricing Model; Video Session Black-Scholes Option Pricing Formulas, Option Greeks

13

17

28

Revision of semester work, Presentations

TEXT BOOKS:
Required: Options, Futures, and Other Derivatives. Seventh Edition. By: John C. Hull. Handouts: SBP Stability Review 2008-09. Section 7.3: Derivatives Market in Pakistan. SBP Financial Derivatives Business Regulations.
KSE Regulations: Regulations governing Cash-Settled Future Contracts.

Recommended: Derivatives: Valuation and Risk Management. By: David A. Dubofsky and Thomas W. Miller, Jr. Derivatives Market. By: Robert L. Mc. Donald.

ASSIGNMENTS:
1. Case Study Presentation: Since the mid-1980, there have been some huge losses incurred from the inappropriate use of derivative instruments. Each group will select one case (either a financial institution or a non-financial institution) and submit a write up covering the following points: Explanation of strategies and transactions involved. What went wrong? How was the loss accumulated? Who was responsible for the loss? What lessons are to be learned from the case/disaster? Case Selection: 3rd session (A list of the institutions incurring losses is given in the course book, chapter 32: Derivatives Mishaps) Source: Secondary Page Limit: 2-5 pages Due Date: 8th session 2. Topic Presentation: Each group will select a topic from our (Pakistans) derivatives market. It could be a particular instrument market or the derivatives transactions executed by an Authorized Derivative Dealer (financial institution). Topic Selection and Approval: Till the 8th session (No assignment will be accepted without prior approval of the topic) A 1-page write up is to be submitted on the 8th session indicating the issues or areas that will be covered in the assignment. Source: Primary and Secondary Page Limit: 4-10 pages Due Date: 1st session after the second term (21st session)

COURSE REQUIREMENTS:
Students must bring text book in the class. The supplementary materials will be handed out in the class. It is anticipated that students prepare the topics in advance to be ready for the discussion and quizzes. Active class participation will be rewarded by adjusting the grade upwards when it is on the margin. Since subsequent topics build on previously learned material, it is imperative that students keep up with the material. In addition, students should ensure that lectures are understood properly. A student who misses a class is responsible for obtaining any handouts and information on course content, assignments, due dates, test dates, etc. Financial calculator is necessary in the class. The quizzes may be in advance or from the previous topic. There will be a perfect zero if you miss the quiz. You are expected to complete the assignments on the due date. No excuses will be entertained in late submission unless there is some extreme case.

GRADING: The course grades will be based on:

Terms Final Quizzes (n-1) Assignments and Presentations Class Participation

40% 35% 10% 10% 5%