Introduction to Derivatives and Risk

Management

Speculative Markets

Outline

Meaning of Speculative Markets Meaning of Derivatives Meaning of Financial Engineering Types of Derivatives Role of Derivatives Sequence of this course

Speculative Markets

A market that deals in derivative securities such as options, futures, swaps, and variants of these products

Why speculative markets? To deal with financial risk management

What are derivatives? A financial instrument that derives its value from

the underlying asset on which it is written

Derivatives are the result of financial engineering

What is financial engineering?

Meaning of Financial Engineering The design, development, and the implementation of innovative

financial instruments and processes, and the formulation of creative solutions to problems in finance

Objective is to provide custom-designed solutions to problems that firms face in the area of financial risk management. Firms’ exposure to financial risk management include interest rate risk, currency risk, commodity price risk, security price risk, and so on.

Financial engineering is the means to implement financial innovation

What is financial innovation? Include not only the creation of new types of securities, but

also the development of and evolution of new financial organizations

Financial engineering embodies many of the skills, techniques, and processes that produce both new securities and new financial organizations.

It is the application of advances in related technologies that permit the diagnosis, analysis, design, production, pricing, and customization of solutions to problems in finance

Why Financial Innovation?

Revolutionary changes in the international financial system

Round the clock trading Tokyo-London-New York Financial futures, swaps, mortgage-backed securities,

exchange traded options Junk bonds Shelf registration, electronic funds transfer and security

trading, NOW accounts, asset-based financing, LBO, etc. Proliferation of organized trading markets in both

equity and fixed-income derivative securities during the past two decades is unprecedented

What does financial innovation do for the markets and participants?

Meet demands for “completing market” with expanded for risk-sharing risk-pooling, hedging, and intertemporal or spatial transfer of resources that are not

already available Lower transaction costs/increase liquidity Reduce agency costs caused by asymmetric information Price Discovery Greater Market Efficiency

Course Sequence

Option Markets Structure Principles Pricing Strategies—basic and advanced

Futures Markets Structure Principles Pricing Strategies

Swaps and Other Exotic Instruments