1. 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.

2. An Introduction to Derivatives and Risk Management, 6th ed.
Class Web Page
syllabus: can be found at the web site
my page:
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.

3. An Introduction to Derivatives and Risk Management, 6th ed.
General Information
BA and IAM 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)
Dr. Z. Nuray Güner
Communication:
Office hrs: (H113) T&Th 16:15-17:30
Phone: (312)
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.

4. An Introduction to Derivatives and Risk Management, 6th ed.
Textbook
An Introduction to Derivatives,
Chance, D.M. 6th Edition, Thomson/South Western, USA, 2004.
D. M. Chance
An Introduction to Derivatives and Risk Management, 6th ed.

5. 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.

6. 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.

7. 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.

8. An Introduction to Derivatives and Risk Management, 6th ed.
list
The course will have an 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.

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

10. 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.

11. 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.

12. 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.

13. 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.

14. 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.

15. 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.

16. 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.

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

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

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

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

25. 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.

26. 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.