Financial Modelling and Derivatives

COURSE OBJECTIVE
In this course you will learn about financial modelling of risk and financial derivatives. In the financial modelling module, the central concept is the relationship between risk and return on financial assets (Knowledge).
The goal of this part of the course is to gain insight into the risk associated with financial portfolios and investments and to be able to calculate/estimate such risk on the basis of historical data. Furthermore, other goal is to learn how to construct portfolios on the basis of mean-variance optimization and how to benefit from diversification possibilities. Finally, another goal is to learn how to compute expected returns on investments on the basis of the Capital Asset Pricing Model and multifactor models (Quantitative skills).
In the derivatives module, the goal is to gain insight into various financial derivatives such as futures and options, their properties, valuation and risks associated with them (Knowledge).
Another goal is to learn how these derivatives can be used to hedge financial risks (Quantitative skills).
Upon accomplishing these goals, you will gain new academic, research and quantitative skills, as well as develop your professional knowledge in the area of financial risk and derivatives. Furthermore, by illustrating the concepts with examples of portfolios, investments and hedging problems provided by financial institutions, we will bridge the gap between theory and practice, enabling you to translate theoretical concepts into practical applications (Link to practice).
 

COURSE CONTENT
Central topics in financial modeling that will be discussed are:
- measures of risk in financial markets: variance and volatility of returns;
- trade-off between risk and return;
- estimation of average return and volatility;
- concepts of covariance and correlation; their estimation;
- risk and return of portfolios;
- diversification;
- universal risk measures: Value-at-Risk and Expected Shortfall;
- concept of efficient portfolio. Markowitz model;
- CAPM;
- risk premium and beta;
- multifactor models of risk. Central topics in the part on derivatives that will be discussed are:
- types and characteristics of financial derivatives;
- use of derivatives in risk hedging;
- options: determining option price with the help of the binomial tree;
- sensitivities of options (Greeks);
- Black-Scholes model for option pricing and its assumptions;
- delta hedging of options;
- implied volatilities and volatility smiles;

METHODS OF TEACHING:
Lectures. Tutorials.

TYPE OF ASSESSMENT
Written midterm test, written exam and computer assignment.

RECOMMENDED BACKGROUND KNOWLEDGE
Finance I and Quantitative Research Methods I and II