Derivative Securities

This subject focuses on the application and valuation of derivative securities, such as forwards, futures, swaps and options. The emphasis will be on arbitrage relations, valuation, and hedging with derivatives. The topics covered include; Forwards and futures: the mechanics of trading, price determination, hedging strategies; Swaps: definition and valuation; Options: payoffs, arbitrage bounds, trading strategies, the binomial model, the Black-Scholes model and its relationship to the binomial, hedging, American options and dividends, options on futures, limitations of the binomial and Black-Scholes Models.

• 1Explain the role of derivatives exchanges and the characteristics of derivative securities;
• 2Explain the role of arbitrage as a basis for determining the prices of derivative securities;
• 3Explain the mechanics of trading futures contracts, forward contracts and options;
• 4Design and manipulate payoff diagrams for various derivative securities;
• 5Calculate option prices using the Black-Scholes and binomial models;
• 6Explain how derivative securities can be used in hedging;
• 7Reflect on the theoretical limitations of key derivatives pricing models and on practical difficulties that arise in their implementation.