Spring 2005 Dept. of BA- IAM METU Dr. Adil Oran Dr. Z. Nuray Güner Financial Derivatives Spring 2005 Dept. of BA- IAM METU Dr. Adil Oran Dr. Z. Nuray Güner D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. Class Web Page http://old.ba.metu.edu.tr/~adil/ba4825/ syllabus: can be found at the web site my page: http://ba.metu.edu.tr/~adil/ D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. General Information BA 4825-5825 and IAM520 Financial Derivatives Class Schedule: M&W 11:45-13:00 G208 Dr. Adil ORAN Communication: Office hrs: (H114) M&T 14:45-16:00 Phone: (312)210-2041 e-mail: adil@ba.metu.edu.tr Dr. Z. Nuray Güner Communication: Office hrs: (H113) T&Th 16:15-17:30 Phone: (312)210-2041 e-mail: nguner@ba.metu.edu.tr D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. Textbook An Introduction to Derivatives, Chance, D.M. 6th Edition, Thomson/South Western, USA, 2004. http://www.swlearning.com/finance/chance/ http://www.harcourtcollege.com/finance/chance/ D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. Course Objectives provide a solid foundation in the principles of derivatives strike a balance between institutional details theoretical foundations practical applications expose students to a rather comprehensive coverage of theory and application in the derivatives area D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. Course Description Hybrid Finance area course Basic knowledge of Mathematics, Accounting, Finance, and Economics is assumed D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. Class Preparation Prior to Class: Read relevant material prepare any assignments given Come to class ready to take part in discussions Ask questions whenever you need to! D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. E-Mail list ba4825@yahoogroups.com The course will have an email list for updates to web content changes in times announcements also good for asking questions subscribe from class web page D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. Grading Midterm 20 Final 50 Assignments 10 Total 100 D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Chapter 1: Introduction The speed of money is faster than it’s ever been. Loleen Doerrer Time, April 11, 1994, p. 33 D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Important Concepts in Chapter 1 Different types of derivatives Risk preferences, risk-return tradeoff, and market efficiency Theoretical fair value Arbitrage, storage, and delivery The role of derivative markets Criticisms of derivatives D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. Business risk vs. financial risk Derivatives A derivative is a financial instrument whose return is derived from the return on another instrument. Size of the derivatives market at year-end 2001 $111 trillion notional principal $3.8 trillion market value Real vs. financial assets D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Derivative Markets and Instruments Options Definition: a contract between two parties that gives one party, the buyer, the right to buy or sell something from or to the other party, the seller, at a later date at a price agreed upon today Option terminology price/premium call/put exchange-listed vs. over-the-counter options D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Derivative Markets and Instruments (continued) Forward Contracts Definition: a contract between two parties for one party to buy something from the other at a later date at a price agreed upon today Exclusively over-the-counter D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Derivative Markets and Instruments (continued) Futures Contracts Definition: a contract between two parties for one party to buy something from the other at a later date at a price agreed upon today; subject to a daily settlement of gains and losses and guaranteed against the risk that either party might default Exclusively traded on a futures exchange D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Derivative Markets and Instruments (continued) Options on Futures (also known as commodity options or futures options) Definition: a contract between two parties giving one party the right to buy or sell a futures contract from the other at a later date at a price agreed upon today Exclusively traded on a futures exchange D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Derivative Markets and Instruments (continued) Swaps and Other Derivatives Definition of a swap: a contract in which two parties agree to exchange a series of cash flows Exclusively over-the-counter Other types of derivatives include swaptions and hybrids. Their creation is a process called financial engineering. The Underlying Asset Called the underlying A derivative derives its value from the underlying. D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Some Important Concepts in Financial and Derivative Markets Risk Preference Risk aversion vs. risk neutrality Risk premium Short Selling Return and Risk Risk defined The Risk-Return tradeoff (see Figure 1.1, p. 7) D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. Some Important Concepts in Financial and Derivative Markets (continued) Market Efficiency and Theoretical Fair Value Definition of an efficient market The concept of theoretical fair value D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Fundamental Linkages Between Spot and Derivative Markets Arbitrage and the Law of One Price Arbitrage defined Example: See Figure 1.2, p. 10 The concept of states of the world The Law of One Price The Storage Mechanism: Spreading Consumption across Time Delivery and Settlement D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

The Role of Derivative Markets Risk Management Hedging vs. speculation Setting risk to an acceptable level Price Discovery Operational Advantages Transaction costs Liquidity Ease of short selling Market efficiency D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Criticisms of Derivative Markets Speculation Comparison to gambling D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Misuses of Derivatives High leverage Inappropriate use D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

Derivatives and Your Career Financial management in a business Small businesses ownership Investment management Public service Source of Information on Derivatives http://chance.swlearning.com Summary D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. (Return to text slide) D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

An Introduction to Derivatives and Risk Management, 6th ed. (Return to text slide) D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.