In the process of the study of Derivatives and Derivative Markets there will arise a need for knowledge of the underlying primary securities and their markets, such as stocks, bonds, stock indices, and foreign exchange. The fundamentals of such instruments and markets will be covered during the course, in order to ensure that all students are brought to the same knowledge plane. Issues pertaining to the operation of derivatives exchanges, and placement and execution of orders on such exchanges will also be dealt with in this course.
Summary: In order to ensure that advanced concepts of futures and options are given adequate coverage, the course has been split into three parts with a combined credit of 4.50 instead of the usual 3.0 credits. This is the third of the three courses and focuses on interest rate and credit derivative products.
The two earlier courses on Futures Markets and Options Markets are pre-requisites for this course. This course will commence with a study of futures contracts on money market as well as bond market products. ED and T-bill futures as well as T-Note and T-Bond futures are covered in substantial detail. The following session is devoted to a detailed study of the Term Structure of Interest Rates, and the theories which purport to explain the same. Interest rate options are the next area of focus. The complexity of this topic was the primary reason for splitting the derivatives course into three parts and devoting 4.5 credits for it. Both equilibrium and no-arbitrage models are examined and the calibration techniques for, both the Ho and Lee as well as the Black-Derman-Toy model, are expounded upon in detail. The valuation of interest rate derivative products such as Forward Rate Agreements, Caps, Floors, and Collars is studied in detail. The next area of study is the important area of interest rate swaps. In this context a brief introduction is also provided to currency swaps. Examples, throughout the course, are given from both the Indian market as well as the markets in developed economies. The course rounds off with a detailed study of the increasingly important topic of credit derivative products.
METHODOLOGY: These courses will rely primarily on the lecture method. There is a prescribed textbook for all the courses. Detailed reading material for topics not covered in the book will be distributed. A number of excellent reference books are available and serious students are strongly encouraged to read further.
Power Point will be the mode of presentation in class. Copies of the transparencies will be uploaded so that students can refer to them and take printouts if required.
The reading material and the transparencies are to a large extent self-explanatory. However some of the subtle nuances of the subject can be appreciated only by having an active and meaningful discussion in class. Consequently regular attendance and focused study is absolutely essential.
Money Market Futures (1 Session)
- Eurodollars - T-bills - Federal Funds - ED Futures - Bundles and Packs - Locking in a Borrowing Rate - Locking in a Lending Rate - The No-arbitrage Pricing Equation - Hedging Rates for Periods Not Equal to 90 Days - Creating Fixed Rate Loans - LIBOR Futures - Euroyen Futures - T-bill Futures - The TED Spread - Fed Funds Futures Bond Market Futures (2 Sessions)
- Fundamentals of Bond Valuation - YTM: A Detailed Exposition - Callable Bonds - Valuation of a Bond Between Coupon Dates - Duration - The Cash Market - The Futures Market - Conversion Factors - Calculating the Invoice Price for a T-bond - The Cheapest-to-Deliver Bond - Seller’s Options - Hedging The Term-Structure of Interest Rates (1 Session)
- Analyzing the Yield Curve - Spot Rates - Relationship Between Spot Rates and the YTM - Yield Curve versus the Term Structure - Bootstrapping - Coupon Yield Curves - Par Bond Yield Curves - Implied Forward Rates - Fitting the Yield Curve - The Nelson-Siegel Model - Theories of the Term Structure Interest Rate Options (2 Sessions)
- Issues in the valuation of Interest Rate Options - Equilibrium Models of the Term Structure - Arbitrage-Free Term Structure Models - The Fundamental Bond Pricing Equation - The Binomial Approach to the Term Structure - Calibrating the Ho and Lee Model - Calibrating the Black-Derman-Toy Model - Forward Rate Agreements - Caps, Floors and Collars Swaps (1.5 Sessions)
- Interest Rate Swaps - Market Terminology - Futures and Options versus Swaps - Valuing an Interest Rate Swap - Terminating a Swap - Equivalence with FRAs - Currency Swaps - Inherent Risks - Valuation of Currency Swaps - Swaptions
Credit Derivatives (2.5 Sessions)
- About Credit Risk - Why Defaults - Evaluating Default Probability: Credit Rating Agencies - Total Return Swaps - Standard Credit Default Swaps - Digital Credit Default Swaps - Basket Credit Default Swaps - Portfolio Credit Default Swaps - Credit Linked Notes - Credit Spread Options - Collateralized Debt Obligations
Suggested Readings/ References:
Text Book: Futures and Options: Concepts and Applications by Sunil Parameswaran, Tata McGraw-Hill
Reference Books:
1. Fundamentals of Futures and Options Markets by John Hull, (Prentice Hall).
2. An Introduction to Derivatives and Risk Management by Chance (South Western).
3. Futures and Options by Edwards and Ma, McGraw-Hill.
4. Futures, Options, and Swaps by Robert Kolb (Blackwell).
5. Derivatives Markets by McDonald (Pearson).
6. Options, Futures, and Other Derivatives by John Hull, Prentice Hall.
7. Options and Financial Futures by Dubofsky, McGraw-Hill.
8. Fixed Income Markets and Their Derivatives by Suresh Sundaresan (Academic Press).
1. Quiz-30%: This will be MCQ based and will have 40% negative marking. 2. Homework-30%: This will be a problem based assignment to be attempted in groups of not more than five members. End-Term Examination-40%: This will be based on logical reasoning and calculation oriented problems. There will be no negative marking. The exam will be Open-Book and Open-Laptop.
Created By: Debasis Mohanty on 08/11/2010 at 03:19 PM Category: PGDM-II Doctype: Document