1. Lecture 1

2.  Syllabus  Class Format Part 1 - Generic Derivatives & Options Part 2 - Futures, Swaps, MBS  Grade  Assignments/Projects  Option Programs  Exam-Computations  Email

3.  Derivatives are financial instruments whose price and value derive from the value of the underlying assets or other variables (ISDA)  Derivatives are a “zero sum game”

4.  1840s Midwest USA farmers  1848 Chicago Board of Trade (CBOT) for grain  1874 Chicago Produce Exchange for butter/eggs  1919 Chicago Mercantile Exchange (CME)  Risk management  Land options  Risk management

5.  OTC vs. Exchanges  Eurex (E-X)  Chicago Board Options Exchange (CBOE)  Chicago Mercantile Exchange (CME)  Chicago Board of Trade (CBOT)  New York Mercantile Exchange (NYMEX)  Hong Kong Futures Exchange (HKFE)

6. Source: Bank for International Settlements

7. Source: WFE/IOMA Derivatives Market Survey 2012

10.  Futures  Options / Warrant  Future options  Swaps  Mortgage backed securities  Forward Rate Agreement  Convertible bonds  Real options

11.  Stocks (example)  Bonds  Indices  Commodities (examples for metal and ag.)  Currencies  Weather  Carbon emissions  Radio bandwidth

12.  Arbitrage  Speculation  Hedging

13.  Call option  Put option  Exercise or Strike Price  Expiration, Exercise, or Maturity Date  Long position  Short position

15.  Forward Contract  Futures Contract -commodities -indexes -interest rates -exchange rates

16.  An agreement between two firms in which each firm agrees to exchange (or Swap) the “interest rate characteristics” of two different financial instruments of identical principal. Types Interest Rate Swaps Currency Swaps

17. Ex - Interest Rate Swaps Aaa CorpBaa Corp L.T. Fixed Loan10%11.5% S.T. Variable Loan7.25%7.50% Swap Aaa Corp Borrows $1mil fixed loan @ 10% BAA Corp Borrows $1mil variable loan @ 7.5% Aaa assumes pmts on variable loan at 7.5% Baa assumes pmts on fixed loan @ 10.75%

18. Aaa BenefitBaa Benefit Pay L.T. @-10.00%Pay S.T. @- 7.50% Get L.T. @+10.75%Get S.T. @+ 7.50% Pay S.T. @- 7.50%Pay L.T. @-10.75% S.T. Sav @+ 7.25%L.T. Sav @+11.50% Net Benefit+.50%Net Benefit+.75% Ex - Interest Rate Swaps Aaa CorpBaa Corp L.T. Fixed Loan10%11.5% S.T. Variable Loan7.25%7.50%

19.  FMAC  GNMA

20. Read McMillan glossary for terminology IBMSept80Call Stock = IBM Expiration Date = 3rd Friday in Sept (Saturday) Position = Long call Strike Price = $80 # of shares = 100

21. IBMSept80Call is selling for $5 Total Cost = 5 x 100 + commissions = $500 +

22. “In The Money” “Out of The Money” Ex. IBMSept45Call

23. “In The Money” “Out of The Money” Ex. IBMSept50Put

24. Intrinsic Value = P - E Premium = Option price Time Premium = O + E - P

25. Ex. IBMSept60Call Price = 65 Call = 7 Strike = 60 Intrinsic Value = 65 - 60 = 5 Premium = 7 Time Value Premium = 7 + 60 - 65 = 2

26. Parity = Intrinsic Value = Cost Over Parity --> E + O - P > 0 Under Parity --> E + O - P < 0

27. Factors in Option Price 1. Stock price 2. Strike price 3. Time to expiration 4. Volatility & distribution 5. Risk free rate 6. Dividends

28. Cross Section Pricing Intrinsic Value Option Price Stock Price

29. Cross Section Pricing / Time Decay Chart Intrinsic Value Option Price Stock Price

30.  Interest Rates  Settlement  Projects  Computer software