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Marshall School of Business Fall 2016

FBE 459

Management of Financial Risk

Hours: T/TH: 10:00-11:50 am JKP 110

Instructor: Professor Mick Swartz
HOH 213
Ph: 213-740-6527
Email: mick.swartz@marshall.usc.edu
Office Hours: Monday 1-4 pm, after class, or by appointment (NOTE: this schedule is up to 11/20; after that, only
by appointment).
Course Objective: This course intends to be an introduction to financial derivatives, namely options, futures and
swaps. The goal is to provide a complete overview of the main characteristics of these securities and pricing and
hedging issues, from the point of view of the investment bank or large investor (rather than from the point of view of
the small investor). The emphasis of the course will be on conceptual issues as opposed to the institutional aspects
(although the basic institutional aspects will be covered). By all standards this is a quantitative class and a good
background in calculus and statistics is highly desirable, if not necessary.
Grading: The grade will be based on class participation, two midterm exams, a project/presentation.
Midterm One: 33%
Midterm Two: 34%
Written Group Project: 22%
Group Video Presentation: 11%
Problems will be assigned on a regular basis and discussed in class (at least the most representative) but not
collected. However, class participation will also include solving problems in class. Working groups will be
established for this purpose.
Exam Dates:
Midterm One: October 6th
Midterm Two: November 17th
Project Due: December 13th
Powerpoint Presentations: November 29th and December 1st depending on group
The Project is a 5-10 page paper discussing the management of a portfolio. Hedging an equity portfolio, hedging a
fixed income portfolio, hedging a commodity, hedging a currency, speculating with equities, speculating with
commodities, speculating with currencies and fixed income portfolios. The portfolio is a group project thru StockTrak, using real time prices on securities throughout the world.
Grade Announcements: One week after the midterm, grades will be posted. Three working days (72 hours) after the
grades are posted, the posted grades become final and no claims on them will be considered.
Required Text: Hull, most recent edition, Prentice Hall.
Recommended Readings: Wall Street Journal. Bloomberg, Reuters, CNBC media.
http://www.cboe.com and CME, CBOT, NADEX
Additional Books:
Cox and Rubinstein, Options Markets, Prentice Hall
Jarrow and Turnbull, Derivative Securities, 2e, South-Western
McDonald, Derivatives Markets, Addison-Wesley
Siegel and Siegel, The Futures Markets: Arbitrage, Risk Management and Portfolio Strategies, Probus
Each lecture represents half a class period.

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Week One
Lecture 1: Introduction.
Course overview.
Financial Risk
Lecture 2: Introduction.
Different options.
Institutional aspects: margins.
Payoff diagrams.
H: 8.
Week Two
Lecture 3-4: Arbitrage Pricing.
Determinants of prices.
Put-call parity.
Price boundaries.
H: 9.
Week Three
Lecture 5-6: Trading Strategies.
One stock and one option.
H: 10.
Week Four
Lecture 7-8: Binomial Pricing Model.
Pricing of American options.
H: 11.
Week Five
Lecture 9-10: Black and Scholes mathematical foundations.
Continuous Time processes.
Itos Lemma.
H: 12-13.
Week Six
Lecture 11-12: Black and Scholes formula.
Assumptions of the BS formula.
Implicit volatilities.
Extensions to the BS formula.
H: 12-13.
Week 7
Lecture 10: Midterm October 6th

Week Eight

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Lecture 13: Hedging options.

H: 15.
Week Nine
Lecture 15: Hedging portfolios.
With options
Portfolio insurance
Value at Risk.
H: 15, 18.
Lecture 16: Numerical Issues.
Estimating volatilities
Numerical valuation methods
Quasi-analytic valuations
H: 16-17, 19.
Week Ten
Lecture 17-18: Options on dividend-paying underlying.
Dividend-paying stock
Options on Stock Indices
Currency options
H: 14.
Week Eleven
Lecture 19: Exotic Options.
Compound options
Barrier options
Lookback options
H: 22.
Week Twelve
Lecture 20-21: Interest Rate Derivatives.
Bond options
Interest rate models
Valuation issues
H: 26, 28-29.
Week Twelve, continued
Lecture 22-23: Interest Rate Swaps.
Plain vanilla swaps
Empirical issues
Swap valuation
H: 7, 30.
Week Thirteen
Lecture 24-25: Introduction. Pricing of Futures and Hedging with Futures.
Forward and future contracts
Marking to market
Institutional aspects
Week Fourteen

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Determination of forward price

Normal backwardation and contango
Index arbitrage
Crosshedging and hedging ratios
H: 2,3,5 and 14.
Lecture 27: Pricing of Futures, Hedging with Futures. Lessons in Derivatives.
Some futures contracts
Options on futures
H: 3,5,14, 32.
Week Fifteen
Dec 13th : Projects Due
November 29th and December 1st Video Presentations and PowerPoints Slides.
Second Exam Nov. 17
Academic Dishonesty: The use of unauthorized material, communication with fellow students during an
examination, attempting to benefit from the work of another student, and similar behavior that defeats the intent of
an examination, or other class work is unacceptable to the University. It is often difficult to distinguish between a
culpable act and inadvertent behavior resulting from the nervous tensions accompanying examinations. Where a
clear violation has occurred, however, the instructor may disqualify the students work as unacceptable and assign a
failing mark on the paper.
Disability: Any student requesting academic accommodations based on a disability is required to register with
Disability Services and Programs (DSP) each semester. A letter of verification for approved accommodations can be
obtained from DSP. Please be sure the letter is delivered to me (or my TA) as early in the semester as possible. DSP
is located in STU 301 and is open 8:30 a.m. 5:00 p.m., Monday through Friday. The phone number for DSP is
(213) 740-0776.

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