Welcome to my course on financial derivatives. This is the second course of two finance courses offered to students at Harvey Mudd College. This course is designed to be an extension of Economics 104, my introductory finance course, which is a prerequisite for this course.
To get a better idea of the topics that we are going to cover, look at the Course Calendar. The topics to be covered include a review of measures of risk and volatility, a discussion and analysis of put and call options, futures, forward contracts and options, swaps, yield-bearing assets, and a lot of advanced theory. We give special emphasis to understanding and using the value and pricing models, and volatility models.
Mostly we want to explore the exotic and fascinating world of financial derivatives. We will begin by simply understanding how they work and for what purpose they are used. Then we probe a little more deeply, after discussing arbitrage and hedging possibilities, to develop rational explanations of their pricing and valuation. We also want students to be aware of the opportunities for hedging and reducing risk offered by derivatives, and to think strategically about their use for these purposes. By the end of the class, students should feel comfortable about this complex financial environment.
Some of you may choose to work in finance for hedge funds, as investment analysts, as quant traders, and so forth. Every year we seem to place more students into this industry (why? because they love quants!!). This course is carefully tailored to help prepare you for job interviews and work in this field.
This course requires that you have taken Economics 104, Financial Markets, or the equivalent at another college. Generally, a student in this class must be very familiar with the structure and operations of equity and bond markets because this course covers the market for derivatives that are derived from those fundamental markets. There is no review of those markets in this class. It is assumed that you know this material already.
There is no textbook formally assigned to this course. There used to be, but the textbook used was intended for graduate-level instruction and as this course was refined over the years, the content drifted away from the text material, becoming specialized for Mudd students and applications that are interesting for that cohort. Therefore we still use the text but only as an optional reference source. It is up to you to decide whether you want to buy it. The textbook is quite good (although very difficult to read) - it is the educational bible for this kind of course. You might decide to share with another student and to buy an older out-of-print edition (there is no meaningful loss in content at all). A new edition of the text is over-priced. The textbook in question is Options, Futures, and Other Derivatives, by John C. Hull, 8th edition, ISBN 0132777428 or any edition if you can get it cheaper, although you will have to sync the chapters to the 8th edition, which is not hard to do.† Do not buy this book before we meet for the first time.
Much of our class information comes from some very detailed PowerPoint slides that I will use in my lectures. We will also rely upon a lot of reading material that is available free from the internet. When the time comes we will simply find it (I provide the URLs), download it, print it, and read it, all for free! The internet has proven to be an increasingly reliable source of good material for courses like this. All slides for my lectures are posted before the lecture on the Course Materials web page.
We also have some interactive course assignments, most of which are based upon applications in Excel workbooks. Some of these we will do together in class, and some you will do after class hours. These assignments also will be made available on the Course Materials web page. Postings to this page will be made as the class proceeds. I will tell you during lectures when it is time to do one of these assignments.† These homework assignments are typically not corrected and are not graded, but exam questions are sometimes based upon these assignments and in some cases I may require you to bring the completed assignment to the examination to extract material for exam questions.
Your grade for this course will be based upon your accumulated scores from three equally-weighted exams, including the final exam. Your final grade will be based upon a final distribution for the class after the final has been taken. The cutoff points for different letter grades are not determined until I have evaluated that final distribution. If you are concerned about your grade prior to the final, do not ask me what score you will have to earn to meet your grade target. I will not know because I will not have seen the final distribution. I donít (really canít) give extra credit assignments to compensate for low exam scores.
You have the right to appeal a grade on an exam so long as the following procedure is used:
To appeal a grade on an exam, you must submit to me the basis of your complaint (explaining why you should have been given a higher score) in writing on an 8 1/2" by 11" sheet of paper within a week of receiving back your graded exam. I will be willing to talk to you at length about your exam, but not about changing the score on your exam, unless you have first followed the procedure above. To this rule I make one exception: if I have improperly posted your grade because I made a mistake adding the score, you need only tell me.
Policy on Pass/No Pass: I automatically allow any student who wishes to take the course on a P/NP basis to do so if the student is eligible. HOWEVER, to receive a passing grade the student must have accumulated enough points to receive the equivalent† C- or better! Prior to the final, do not ask me how many points you must earn on the final to pass. I will not tell you because I will not know. Your final grade will depend upon the final distribution after the final has been taken. Also, if you are P/NP status, to earn a passing grade for this class, regardless of your prior scores, you must pass the final exam. If you receive a score on the final exam alone that I deem to be a failing grade, and you are registered as a P/NP student, I will assign an F for the course. This policy does not apply to students taking the course for a grade (because you are merely going to get a very low grade).
About the somewhat unstructured nature of this course: This course covers some very complex material at a very advanced level. This course is taught at a level used in the second year of a Ph.D. program in finance (based upon the book used in this course). This material can be very challenging for both the student and the teacher. This stuff is difficult to teach. Also this course is extremely lecture-dependent. The reference reading material is difficult to understand without explanation. Further, although the scheduling of material in this course is linear - we go systematically from one detailed topic to another according to a plan for the whole semester developed long before the semester started, I cannot guarantee the pace of progress because I will not move on from one topic to the next until I am sure the class understands it (it builds in the major sections - if you don't understand step 1 you won't understand step 2). I experiment with how I teach. I constantly discard or change lectures. Some thrusts fail. In some areas we have to backtrack.
[Look at the Course Calendar at this point]. It is for this reason that although we will move systematically down the Course Calendar, I cannot say for sure where we will be when it is time for our first exam. I think that will have completed all of Section 3 Futures Fundamentals, but maybe not. Or maybe we will be past that. You have to connect to my lectures and we will work together to manage this class - but be forewarned, there is a certain chaotic element to this class (I insist that it has to be taught this way to be a good class - this will never change, no matter how many times I teach it - it is the nature of the subject matter).
This is like a road trip to Pagosa Springs. We know where we are going, not quite sure how.
Video and Audio: You are not allowed to use video or audio recording equipment in my classroom without my express written permission (permission by email constitutes written permission). If you have some reason to do it, you might ask and I might allow it. There are two reasons for this: (1) all of my material including oral presentations is my copyrighted material and I have the right to control it, and more important, (2) unauthorized recordings can have a stifling affect upon free and open speech. What goes on in the classroom is between you and me, not you and me and everyone who watches YouTube.
Class Lecture Videotapes in 2014: In 2014 we are going to experiment with using MediaSite to autotape my lectures to video to be posted immediately after the class. The full lecture will be maintained for either two or three weeks, then it will be erased. This will give busy students the opportunity to miss a lecture and make up for it later. I intend to distribute an online survey to evaluate how students used this service and what you think of it.
I do hold regular office hours, which will be announced in class but, given your busy schedules, whatever hours I might choose might conflict with most of yours. If you merely drop by there is a good chance you will find me. I do make appointments - that way we can meet at a time convenient to both of us. The best way to make an appointment is by email. If you ask after class and I don't have my calendar with me, I might forget! My email address is
firstname.lastname@example.org† or email@example.com
The detailed schedule for the course, including exams, is shown on the Course Calendar.