(Concentration III)
The “Fundamentals of Financial Derivatives” course is a BBA program offered at colleges affiliated with Pokhara University. This course is designed to provide students with a comprehensive understanding of financial derivatives, their mechanisms, and their applications in risk management and investment strategies. The syllabus outlines key topics and skills that students will explore, equipping them with the knowledge necessary to navigate the complexities of financial markets.
Table of Contents
Course Objectives
The objective of the course is to familiarize students with the basic financial derivative instruments and their pricing principles. In particular, this course focuses on the economics of pricing derivative instruments, such as option, future, forward and swap. This course also helps students to design strategies for hedging risk by using the different financial instruments.
Course Description
This is the first course in financial derivatives. Therefore, it begins with an introduction to derivatives and derivative markets and moves to basic principles of options and option pricing. Then it deals on forward and future markets, swaps, and over-the-counter derivative instruments; and finally, deals on derivative markets in the context of Nepal.
Course Outcomes
By the end of this course, students should be able to:
- understand basic concepts, principles and practices related to derivative securities and derivative markets;
- understand option related terminologies, interpret option quotations and calculate payoff from option positions;
- value options using binomial and Black –Scholes-Merton option valuation models;
- pricing forward and future contracts and use them for hedging against risk;
- understand the significance of various swaps;
- familiarize with over-the-counter derivative instruments; and
- designing strategies for hedging risk.
Course Contents
Unit I: Introduction to Financial Derivatives – 5 hours
Derivative markets and instruments; core concepts in financial and derivative markets; spot and derivative markets; role of derivative market; myths in derivative markets; ethics in derivative markets; and career in derivative markets.
Unit II: Structure of Option Markets – 5 hours
Option terminologies; development of options markets; call and put options; over-the-counter options market; exchange-listed option trading; mechanics of trading; option quotation; types of options; transaction costs in option trading; and regulation of option markets.
Unit III: Principles and Model of Option Pricing – 12 hours
Principles of call and put option pricing; call-put parity; binomial options pricing model: features, single and multi-period binomial model;Black-Scholes-Merton options pricing model: assumptions, formula, factors affecting option price.
Unit IV: Forward and Future Contracts – 10 hours
Development of forward and future markets; forward vs. future markets; future traders; mechanics of future trading; principles of pricing forwards and futures: interest, cost of carry, convenience yield, and risk; difference between forward and future prices and the sources of difference; hedging with forward and futures: basis, short and long hedging, hedge ratio, and the risk of hedging.
Unit V: Swaps – 5 hours
Concept, nature and features of swaps; interest rate swaps; currency swaps; and equity swaps.
Unit VI: Over-the-Counter Products – 6 hours
Interest rate options: caps, floors and collars; Swap options; Exotic options; Credit derivatives: credit default swap, credit default exchange swap, credit spread derivatives, total return swap and credit-linked note; and difference between securitization and credit derivatives.
Unit VII: Derivative Markets in Nepal – 5 hours
Development of derivative markets in Nepal; instruments traded in the market; mechanics of trading, regulation of derivative markets in Nepal; and issues in derivative markets of Nepal.
Basic texts
- Chance, D. M. and Brooks, R. An introduction to derivative and risk management. New Delhi: Cengage Learning India Pvt. Ltd.
- Kumar, S. Financial derivatives. New Delhi: Prentice – Hall of India.
References
- Hull, J. C., and Basu, S. Options, futures, and other derivatives. Singapore: Pearson Education Singapore Pvt. Ltd.
- Parasuraman, N.R. Fundamentals of Financial Derivatives. New Delhi: Wiley India.