Stockholm School of Economics

Fall 2016

Derivatives in Investment Management

(Course 643)

Instructor: Professor Irina Zviadadze

Department of Finance,
Stockholm School of Economics,
Drottninggatan 98,
Office: 3448
E-mail: Irina.Zviadadze@hhs.se
TA 1: Yavor Kovac

Course Administrator: Anneli Sandbladh

Department of Finance
Stockholm School of Economics,
Drottninggatan 98,
E-mail: yavor.Kovachev@phdstudent.hhs.se

Department of Finance
Stockholm School of Economics
Drottninggatan 98
E-mail:Anneli.Sandbladh@hhs.se

TA 2: Philip Hamna
Department of Finance,
Stockholm School of Economics,
E-mail: Philip.Hamna@hotmail.com

Class schedule and location

We meet twice per week. Yavor Kovachev and Philip Hamna will hold tutorials on
Fridays (usually). Yavor teaches from 8:15 until 10:00 (seminar group 1), Philip teaches
from 10:15 until 12:00 (seminar group 2). Please note that there is no tutorial on
September 2nd. Also note that the seminar group 1 has their tutorial on September 14th
from 13:15 until 15:00 (instead of September 16th). Please attend lectures and tutorials
with the seminar group you are assigned to or ask my permission to switch your group.
Yavor and Philip (TAs) will review basic math related to the course material,
assignments, and cover additional problems sets that will help you understand lecture
notes and apply theory in practice.

I will hold office hours by appointment. Please do not be shy about contacting me. I will
be happy to help. E-mail is great for brief and clarifying questions. Office visit is better
for more extended help.
Please direct any questions you may have about grading or problem sets discussed in
tutorial sessions to the TA assigned to your group. If you want to set up a meeting with
your TA, please email him.

Course Objectives
Derivative instruments such as futures, swaps and options are now an indispensable part
of the toolkit of all financial practitioners, from investment managers to CFOs. The
purpose of this course is to provide you with the necessary skills that will enable you to
be a sophisticated, informed user of derivatives. You will acquire a robust conceptual
understanding of the fundamental issues that determine the use, valuation and behaviour
of these instruments. You will be expected to be able to price all types of derivatives
contracts discussed in the course and discuss the strategic issues associated with
derivatives usage in contexts related to corporate hedging, portfolio hedging, hedge fund
strategies, and other applications.

Prerequisites
Because of the important role played by mathematical models in derivatives markets, the
course is necessarily quantitative. Though advanced knowledge of calculus is not
required, you should be comfortable with basic properties of functions and random
variables, as well as differentiation rules.
I will ask Yavor and Philip to review key mathematical concepts during the tutorial
sessions.
If you need a further math refresher, you might want to consult one of the following texts,
both of which include lots of worked problems and examples.

Mathematics for Economists by M.Pemberton and N.Rau, 2nd ed., Manchester

University (2006);
Mathematics for Economics and Business by Ian Jacques, 5th ed., FT Prentice Hall
(2006).
In addition, you should be familiar with the material from Finance 1 Investment
Management. As a reference book, you may want to use
Investments by Z. Bodie, A. Kane, and A. Marcus, McGraw-Hill (7th Edition or later)
Course Grade
The course grade will be based on your homework assignments (the cumulative
homework score will contribute 20%), midterm exam (10%) and the final exam (70% of
your grade).
Homework will be assigned on September 5, September 12, September 26, and
October 3 and is due in class one week after it is handed out. The assignments must be
completed in groups of four people (groups of three are only allowed to the extent the
number of students in the class makes it necessary ask Yavor or Philip for permission).
During the first week of the course, please email to your TA a proposed composition of
your group and wait for their confirmation. All group participants should be assigned to
the same seminar group. When you submit your assignment, please bring a paper copy of
your work and indicate the names of all group members on the front page. Late work and
electronic submissions will not be accepted. Your solutions will be returned the week
after they are due. Answers will be distributed and discussed in practice sessions.
Midterm exam takes place on September 28. There is no re-sit unless you have a doctor
certificate indicating that you were ill on the midterm exam day. The midterm exams
duration is 45 mins. It is short and simple if you understand home assignments well.
I expect regular attendance of lectures and active participation by students therein. I
strongly recommend students to attend tutorials and clarify all their questions in a due
course before the exam week. Yavor and Philip will review home assignments (45 mins)
and discuss new problem sets (45 mins) during the tutorials.
Final examination will test students ability to price derivatives as well as their
understanding of how to use derivatives strategically in practice. You will be only
responsible for material covered and assigned by the instructor. The exam will be closed

book. One page of notes and an ordinary pocket calculator will be allowed (calculators
with built-in text memory are not allowed). Some of the problems on the final exam will
be taken from the homework assignments with only minor changes. This is an incentive
to do homework yourself. Exam is scheduled to be on October 25th, 2016 (13:00-16:00).
Readings and Reference Materials
Each week I will distribute copies of the lecture notes which are fairly self-contained. As
a reference volume, I recommend and will give readings from the following book:
Options, Futures, and Other Derivatives by John Hull, (7th, 8th, or 9th ed.), Prentice
Hall.
You can use a different edition of the book but please note that the same chapters have
different numbers in different editions. Please consult with me if you are not sure which
chapters you are supposed to read from your book.
Class Session Outline
The following outline gives an overview of the main topics we will be covering and the
associated recommended readings.
Week 35: Introduction to Derivatives, Forwards and Futures
Topics:
What are derivative contracts
Forwards and Futures contracts
Suggested readings: 1, 2, 4, 6.2 from Hull 8
Additional readings (advanced/not for the exam):
Grinblatt, Mark and Francis Longstaff, Financial Innovation and the Role
of the Derivative Securities: An Empirical Analysis of the Treasury
STRIPS Program, Journal of Finance, Vol LV, 2000
Jorion Philippe, Risk Management Lessons from Long-Term Capital
Management, European Financial Management, 6, 2000
Week 36: Forwards and Futures contd
Topics:
Pricing of Forwards and Futures
Commodity Futures

Hedging and speculation with Forwards and Futures

Suggested readings: 3, 5 from Hull 8
Additional readings (advanced/not for the exam):
Johnston, Elizabeth Tashjian and John McConnell, 1989, Requiem for a
Market: An Analysis of the Rise and Fall of a Financial Futures Contract,
Review of Financial Studies, 2
Week 37: Swaps
Topics:
Introduction to Swaps
Valuation of Swaps
Usage of Swaps for Hedging and Investment
Commodity Swaps
Interest Rate Swaps
Currency Swaps
Suggested readings: 7 from Hull 8
Additional readings (advanced/not for the exam):
"The Wheatley Review of LIBOR: initial discussion paper"
Abrantez-Metz Rosa and Michael Kraten and Albert D Metz and Gim
Scow, "LIBOR manipulation", Journal of Banking and Finance, 2012
Week 38: Introduction to Options
Topics:
Introduction to Options
No-arbitrage pricing relationship
Trading strategies
Suggested readings: 9, 10, 11.2--11.5, 12.1 from Hull 8
Additional readings (advanced/not for the exam):
Kelly Bryan, Hanno Lustig, Stijn Van Niewerburgh, "Too-systematic-tofail: what option markets imply about sector-wide governement
guarantees", American Economic Review, forthcoming
Kelly Bryan, Lubos Pastor, Pietro Veronesi, "The price of political
uncertainty: theory and evidence from the option market", Journal of
Finance, forthcoming

Week 39: The Binomial Model

Midterm exam (45 mins)
Topics:
The Binomial Model
Dynamic replication and arbitrage in a binomial world
European and American options, with and without dividends
American options and early exercise
Option, leverage and expected returns
Suggested readings: 12 from Hull 8
Additional readings (advanced/not for the exam):
Jensen Mads Vestergaard, Lasse Heje Pedersen, "Early option exercise:
never say never", Journal of Financial Economics, 2016

Week 40: The Binominal Model and The Black-Scholes-Merton Model

Topics:
The Black-Scholes-Merton Model; assumptions, formulae, limitations, extensions
The Greeks and their use
Suggested readings: 14, 18 from Hull 8
Additional readings (advanced/not for the exam):
Jurek Jakub, "Crash-neutral currency carry trades", Journal of Financial
Economics, 2014
Week 41: The Black-Scholes-Merton Model in Practice
Guest lecture
Topics:
Delta hedging
Historical and implied volatility; VIX
Volatility derivatives and strategies
Improving Black-Scholes Model
Suggested readings: 19, 22.1, 22.2, 25.15, 26.2 from Hull 8
Additional readings (advanced/not for the exam):
Broadie Mark, Mikhail Chernov, and Michael Johannes, "Understanding
Index Option Returns", Review of Financial Studies, 2009
Martin Ian, "Simple variance swaps", Working paper

Week 42: Exotic options & Course wrap-up

Suggested readings: 25.825.13, 26.526.6, 20.6 from Hull 8
Week 43: Exam
Additional notes
I reserve the right to make changes regarding the course -- e.g., course content, format of
exam, schedule, deadlines, etc. I will give you advance notice if necessary.
Mobile phones are not allowed in class. If you have a phone, please turn it off and put it
away before the class starts. Classes start on time. Please do your best to arrive on time.