1. Finance 416 Derivatives and Risk Management
Rich Jakotowicz, CFA, CFP®
Department of Finance
318Purnell Hall

2. Topics covered in this course
Mechanics of Forward, Futures, and Swap Markets
Pricing of Forward, Futures, and Swap Contracts
Hedging with Futures
Interest Rates
Swaps
Mechanics of Option Markets
Hedging with Options
Pricing of Options
Employee options
Volatility and Value-at-risk

3. Why study derivatives? They are very useful: Risk management
»base derivative position on risk exposure
»“delta hedging” “portfolio insurance”
»need to understand how derivatives payoff
Speculation
»base derivative position on forecast
»need to understand derivative payoffs and pricing
Arbitrage
»base derivative position on apparent mispriced assets or portfolios (program trading)
»need to understand how derivatives are priced
Compensation!

4. Source: Committee on the Global Financial System Paper Nov
Source: Committee on the Global Financial System Paper Nov for the bank of International Settlements

5. Why study derivatives? Losses
Metallgesellschaft $1b oil derivatives ‘93
Gibson Greetings $20m interest rate swaps ‘94
Proctor and Gamble $157m interest rate swaps ‘94
Orange County $1.5b structured notes ‘94
Barings, PLC $1.3b options and futures ‘94
Sumitomo $2.6b copper contracts ‘96
LTCM $1.6b swap contracts, $1.3b equity volatility contracts ’98
Jpm B
Value created everyday, however, fails to garner attention from the media

6. Types of Derivatives Primary Contracts Complex Derivatives
Forwards and Futures
Swaps
Options
Complex Derivatives
Caps, Floors, and Collars
Bear, Bull, and Butterfly Spreads
Strips, Straddles, and Strangles
Liquid Yield Option Notes (LYONs)
Indexed Currency Option Notes (ICONs)
Captions, Swaptions
Exotic Derivatives
Resets, Asians, Lookbacks, etc…

7. Appropriate background for this class:
Material from Basic Finance
Time value of money
CAPM & Beta
Interest rates
College Algebra and Economics
Calculus is useful, but not required
Statistics
variance, correlation, regression analysis
Bloomberg
A Bloomberg login ID will be needed.
You do not need to know how to use Bloomberg

8. Class requirements Two exams (35% each) One project/quiz (15% total)
You will build options pricing models in Microsoft Excel and use your models for the quiz
Excel Model (5%)
Quiz (10%)
The Options Trading Game - OTG (15% total)
Submit weekly trades (4%)
Final Analytical Paper (11%)

9. Goal of the course: Fluency in derivatives
Risk Management:
Individual, corporate, and financial institutions
Financing Decisions:
Cost of debt, compensation
“Speculative” Investments:
Individual, corporate, and financial institutions

10. Watch list Treasury yield curve
3-month LIBOR (London Interbank Offer Rate)
Fixed for Floating Swap Yield Curve
S&P 500 Index (spot & futures)
VIX Volatility Index
Commodity Futures: WTI Crude Oil & Nat Gas
USD vs G7 FX (spot & forwards)