Lahore University of Management Sciences

Finn 222 – Introduction to Mathematics of Finance

Fall 2020
(Online Semester)
Instructor Ferhana Ahmad
Room No. 314 – SDSB building
Office Hours By appointments through email
Email [email protected], [email protected]
Telephone 042 3560 8044
Secretary/TA Sharha Mumtaz/TBD
TA Office Hours TBA
Course URL (if any) suraj.lums.edu.pk

Course Teaching Methodology (Please mention following details in plain text)

 Teaching Methodology: The teaching methodology will be a mix of both synchronous and asynchronous lectures. Details are provided
against each session in the outlines below. The classes, where synchronous, will be conducted using zoom. Lecture recordings will be
available on lms after the sessions.
 Lecture details: Around 10-20% sessions will be recorded.

COURSE BASICS
Credit Hours 3
Lecture(s) Nbr of Lec(s) Per Week 2 Duration 1.25 hours
Recitation/Lab (per week) Nbr of Lec(s) Per Week Duration
Tutorial (per week) Nbr of Lec(s) Per Week Duration

COURSE DISTRIBUTION
Core No
Elective Yes
Open for Student Category Open for all
Close for Student Category None

COURSE DESCRIPTION

With the recent developments in Finance over the past decade, the usefulness of Mathematical tools in Finance has become
significant than ever. The course provides an introduction to mathematics of finance and is ideal for developing an understanding
and knowledge of basic mathematical finance that a student requires throughout his or her academic and professional career. It
introduces the vocabulary of mathematics of finance that helps developing the understanding of financial instrument at large. The
course serves as the basis for higher studies in finance, quantitative finance, computational finance, financial engineering,
financial economics, economics, insurance, actuarial sciences or any similar field. The course will broaden your horizon of finance
and financial industry. Not only that the course is essential for the undergraduate and graduate studies in finance but also plays
an important role in the student’s performance in their professional careers.

The course covers topics including basics of calculus, time value of money, theory of interest, probability, normal random variables
and probability, arbitrage theorem, random walks and Brownian motion.

COURSE PREREQUISITE(S)
 Lahore University of Management Sciences
 Principles of Finance
Calculus I

COURSE LEARNING OBJECTIVES

The course helps students to get over their fear of mathematics as a student enrolled in SDSB. The course will

 develop the vocabulary of mathematics of finance

 familiarize students with basic mathematical tools that are used in finance
 introduce students to probability theory required in finance
 introduce students with the concepts of randomness in finance
 prepare students to take advanced courses in finance and quantitative finance

LEARNING OUTCOMES
Upon completion of the course, students will be able to;

 apply basic mathematical concepts used in finance

 implement the learnt theory of interest rates in other courses and in their professional lives
 apply the randomness concepts in finance and probability
 model randomness using Brownian motion
 simulate a simple random walk
 simulate stock prices as random processes

UNDERGRADUATE PROGRAM LEARNING GOALS & OBJECTIVES

General Learning Goals & Objectives
Goal 1 –Effective Written and Oral Communication
Objective: Students will demonstrate effective writing and oral communication skills
Goal 2 –Ethical Understanding and Reasoning
Objective: Students will demonstrate that they are able to identify and address ethical issues in an
organizational context.
Goal 3 – Analytical Thinking and Problem Solving Skills
Objective: Students will demonstrate that they are able to identify key problems and generate viable
solutions.
Goal 4 – Application of Information Technology
Objective: Students will demonstrate that they are able to use current technologies in business and
management context.
Goal 5 – Teamwork in Diverse and Multicultural Environments
Objective: Students will demonstrate that they are able to work effectively in diverse environments.
Goal 6 – Understanding Organizational Ecosystems
Objective: Students will demonstrate that they have an understanding of Economic, Political,
Regulatory, Legal, Technological, and Social environment of organizations.
 Lahore University of Management Sciences

Major Specific Learning Goals & Objectives

Goal 7 (a) – Discipline Specific Knowledge and Understanding
Objective: Students will demonstrate knowledge of key business disciplines and how they interact
including application to real world situations (Including subject knowledge).
Goal 7 (b) – Understanding the “science” behind the decision-making process (for MGS Majors)
Objective: Students will demonstrate ability to analyze a business problem, design and apply
appropriate decision-support tools, interpret results and make meaningful recommendations to
support the decision-maker

Indicate below how the course learning objectives specifically relate to any program learning goals and
objectives.

PROGRAM LEARNING GOALS AND COURSE LEARNING OBJECTIVES COURSE ASSESSMENT ITEM
OBJECTIVES
Goal 1 –Effective Written and Oral The course provides an opportunity to Written: Assignments, Quizzes
Communication students to write and deliver effectively Oral: CP
the mathematical nature problems arising
in Finance.
Goal 2 –Ethical Understanding and
Reasoning
Goal 3 – Analytical Thinking and Problem The course equips students with basic Assignments, Quizzes, Exams
Solving Skills problem solving techniques in Finance
using quantitative methods. It enables
students to analytically think a problem
and solve it using the problem solving
techniques they're learning throughout
the course
Goal 4 – Application of Information Students will simulate stock prices using Class work and Assignments
Technology Excel
Goal 5 – Teamwork in Diverse and The course forces students to learn in Assignments and Projects
Multicultural Environments teamwork. The discussion on assignments
and lecture notes will help them in
working in diverse environments
Goal 6 – Understanding Organizational NA
Ecosystems
Goal 7 (a) – Discipline Specific Knowledge Students will learn quantitative skills in Quizzes, Assignments, Project, and Exams
and Understanding finance that they can apply and model the
real world financial situations/problems
Goal 7 (b) – Understanding the “science” This is a basic course in mathematics of
behind the decision-making process finance. Students will learn tools that may Assignments, Quizzes, and Exams
help them in future if they opt for
Quantitative finance career in designing
and solving a problem in finance using
quantitative skills.
 Lahore University of Management Sciences
Grading Breakup and Policy

Assignment: 10%

There will be one individual excel based assignment during the course (in module 4) where students have to simulate a random walk for stock
behavior and price different option contracts (as taught in the course).

Quizzes (Short exams): 5*15%

There will be 6 quizzes/exam throughout the semester. Each quiz will be for 15%. One quiz will be dropped for any connectivity or other issues that
students may come across during the semester. The quizzes will be announced and timed through LMS. No re-take of exams will be allowed. The
quizzes may be lms based or submission through lms based and will be announced beforehand. Outlines provide an idea of the topics after which
exams/quizzes may be conducted.

Please note that no late submission for CP or project will be entertained. Missed deadlines mark zero for the instrument even with OSA petition.
Please also note that there is no make-up quizzes/short exams or projects or CP in case of absence (even approved by OSA). There is no grade
for attendance, however being absent from class will reflect in reduced CP and other instrument grades.

Class Participation: 5%
The students are required to go through the slides, chapters and any supporting material that is uploaded before the class session and upload a
handwritten/video/audio summary of key concepts for the sessions or solve and upload handwritten answers to given questions through lms. In
case of statements, it’s advised to not go beyond a total of 10 statements. We may replace a session’s CP with a chapter-end questions. This will be
announced beforehand. The CP tabs will be opened on previous day to avoid any last moment connectivity issues. Therefore once overdue and
tabs being closed, the CP submissions will not be entertained. Please also note that for your CP to be marked, the students are supposed to attend
the following session.

Class activities: (10 %)

Students will be given questions to solve during the sessions which they are to submit as a pdf/picture through lms no more than 10 minutes after
the session ends. Tabs will be opened at the beginning of the session and students can submit it any time once the activity is announced before the
deadline.

Class rules:

 You are advised to be on time in sessions. There will be no class participation for students missing or being absent from session for
more than 10 minutes. Please notify the instructor and TAs (along with a proof) if you are facing any connectivity issues preferably
before the class(es) if it’s a persistent issue.
 Use of mobile phones, bringing food, or creating disturbance in the class will mark you absent for the session.
 In case of any absences, even approved from OSA, the CP for the session will be marked zero.
 Students are required to keep calculator and basic stationary while attending the sessions for class works and notes.
 Students are advised not to miss a lecture session for topics taught in the sessions are interlinked and missing a session means less
to no learning in the following sessions (or in the course).

EXAMINATION DETAIL

Yes/No: YES
Combine Separate:
Midterm
Duration: 1 hour 15 minutes
Exam
Preferred Date:
Exam Specifications:
 Lahore University of Management Sciences
Yes/No: YES
Combine Separate:
Final Exam Duration: 2 hours
Exam Specifications:

     
 Lahore University of Management Sciences

COURSE OVERVIEW

The course outlines are subject to change

WEEK/
RECOMMENDED
LECTURE/ TOPICS SESSION OBJECTIVE(S)
READINGS
MODULE

Basics of Calculus
The module is based on the revision of the basic mathematics and calculus concepts that students have already learnt in Further
mathematics or Calculus I. The module prepares students to look at finance from mathematical side. The module reviews the real
number system, vectors and array, polynomial and series concepts along with functions, their derivatives and integration.

 Students will revise the

Thomas’ Calculus (Review) concepts of limits &
continuity, derivatives and
Ch: 3 (Differentiation) (3.1, 3.2, integration
3.5 (chain rule))
1-3 Ch: 4 (Optimization) (4.1, 4.3,  They’ll apply the concepts on
(September 4.4) (maxima and minima finding maxima and minima –
7, 9 & 14) Calculus Ch5: (Integration) the first step towards
5.4(Fundamental theorem optimization
of calculus)
(Synchronous session)

 Students will learn the

sequences, series and sums

4-5 Thomas’ Calculus  Application of series to

September 16 Calculus Ch:11 (746-748, 761-765,794- present value
& 21 795,800,805-808) computations
Taylor Series expansion
(Synchronous session)

6 Students will learn

September 23  functions of multiple variables
Thomas’ Calculus  how to take derivatives of a
multivariate function
Ch:14 (965-966, 14.2,14.3,14.4)  how to interpret the
Partial Derivatives derivatives
Mean Value optimization  the application of partial
derivatives in Lagrangian
optimization (Overview of
Mean Variance optimization
problem)
 Lahore University of Management Sciences
(Synchronous session)

(Overview)
Zill & Cullen Students will learn first order
differential equations and their
Chapter 1.1 (pages 2-5) solutions using integrating factors
Introduction to first order differential Chapter 2 (2.2,2.3,2.4) and separation of variables
equations
Differential equations are an
7 integral part of financial
September 28 modeling. The session will
prepare students to think about
analytical solutions, if any, of the
financial instruments and
modeling of the financial
instruments.
(Synchronous session)
Principles of Managerial Finance Time value of money concepts
Time value of money 13th Edition Chapter 5 (Finn 100 will be given and discussed with
readings) students to emphasize the need
8 to mathematical concepts to
September 30 Paul Wilmott introduces model interest rates and other
Quantitative Finance financial instruments
Second Edition Chapter 1 (1.6) (Synchronous session)

Kavin J Hasting Students will learn

Theory of interest rates Ch: 1 (1.1,1.2,1.3 & 1.6)  Rate of return and
present value
9  Compound interest
October 5  Annuities
 Measuring rate of return
 Continuous time interest
(Synchronous session)
Students will be given the
J Robert Buchanan concept of arbitrage in finance.
Arbitrage Pages (81-84) They will be provided with
Kevin J Hastings (5.1.2) example of taking advantage of
10
arbitrage and how pricing is
October 7
Students are advised to bring mostly based on no arbitrage
examples of arbitrage for class arguments
discussion (Synchronous session)

Students will learn to price

11 Pricing of Financial Instruments using Class Notes futures and options contract
October 12 Arbitrage arguments using arbitrage arguments
(Synchronous session)

Probability Theory
Randomness is a core concept in finance, especially when we model the financial securities and instruments. It provides the
analytical tools to solve practical problems in the complex and rapidly evolving world of today's financial industry. Due to the
randomness involved in the financial industry, we work in a probabilistic way. The module provides the essential concepts that are
 Lahore University of Management Sciences
required for defining and understanding the modeling of a Brownian motion.

Students will learn the concepts

Grimmett & Stirzekar in probability theory from a
Probability theory mathematical side. The will learn
Random experiments, random variable, Chapter 2 (2.1 (25-29), 32)  What constitutes a random
12 events, sample space experiment
October 14  What is a random variable
 What we mean by events
 How do we define sample
space
(Synchronous session)
In this session, they will learn
Grimmett & Stirzekar  The concepts required to
Algebra, Sigma algebra, filtration, define probability space
measure, probability measure, probability Chapter 1: (Pages 1-14)  Concepts such as algebra,
13-14 space sigma algebra, filtration will
be introduced to students
(October 19  Measure will be defined as a
& 21) function
 Probability measure and
probability space will be
defined
(Synchronous session)

Expectations, conditional expectations, Grimmett & Stirzekar Expectations, conditional

15-16 independence Ch: 3 (3.1,3.2,3.3,3.7) expectations and independent
October 26 & Ch:4 (4.1,4.2,4.3,4.6) events will defined using
28) mathematical definitions

(Synchronous session)
Normal distribution has an
essential role in the theory of
Normal distribution, mean variance and J Robert Buchanan randomness in finance. The
moment generating function Chapter 3 distribution function, mean,
Log-normal distribution variance and moment generating
function of a normal distribution
17-18 will be discussed in the sessions.
(November 2 The usage of moment generating
& 4) function in finding moments will
be discussed. By the end of the
sessions, students will be
comfortable will the concepts
that are required in stochastic
calculus.
(Synchronous session)

Randomness concepts in Finance

The module on randomness concepts in finance provides the basics of quantitative and computational finance. The module starts
with discussion of a random walk, the pattern the stocks follow in reality are discussed for comparison. Brownian motion is defined
and its properties are discussed as the basic ingredient of the mathematics of finance and stochastic calculus. The modeling of
 Lahore University of Management Sciences
financial instruments is all based on the concept and modeling of randomness. The students will learn those basic concepts in the
module
Students will learn
J Robert Buchman  the concept or randomness
Session 19
Random Walk Chapter 5  random walk and its properties
 how to formulate a random
November 9
walk
(Synchronous session)
Brownian motion will be defined
J Robert Buchman as
Chapter 5  as a continuous time limit of a
random walk
20 Brownian motion  as a random variable from a
November 11 normal distribution
 Alternative definition of a
Brownian motion

(Synchronous session)
 Students will learn different
properties of Brownian
J Robert Buchman motion such as scaling, time
Properties of Brownian motion Chapter 5 inversion, time reversal
martingale, markov process  The will learn to show
Ubbo F Wiersema whether a process is a
Pages (31- 37) Brownian motion or not
 Students will learn
martingales and will show
that Brownian motion is a
21-22
martingale
 Students will learn the
(November
Markov property and will
16 & 18)
show that the BM is Markov

(Recorded sessions)
Students are advised to use
discussion forms (in place on
lms for these sessions) to
discuss any problems they are
facing in the session content-
wise

23  We model stock prices as a

geometric Brownian motion,
November 23 in this session students will
learn the properties of a
Geometric Brownian motion and its Lecture Notes geometric Brownian motion
properties,
(Recorded sessions)
Students are advised to use
discussion forms (in place on
lms for these sessions) to
 Lahore University of Management Sciences
discuss any problems they are
facing in the session content-
wise

November 25 Class off in lieu of Midterm/Short exams

Revision/ Synchronous session on module - The problems, raised in the
25 4 recorded sessions previous session, will be
November 30 discussed in the session
(synchronous)
Stock prices as a lognormal process Students will learn the
John Hull - stock prices as a lognormal
Pricing options using Monte Carlo Chapter 8 process
26 Simulation - Applications of modeling
(December 2) randomness
- Monte Carlo simulation for
pricing an option
(Excel based – synchronous)

TEXTBOOK(S)/SUPPLEMENTARY READINGS
1. J Robert Buchanan. An Undergraduate Introduction to Financial Mathematics, World Scientific Publishing Company, 3rd
Edition, [ISBN 9789814407441] (Finance and Randomness)
2. Kevin J. Hastings. Introduction to Financial Mathematics, Chapman and Hall, 2015. [ISBN 9781498723909] (Finance and
Randomness)
3. Geoffrey R Grimmett and David R Stirzekar, Probability and Random Processes, Oxford University Press, 3 rd Edition, 2001.
[ISBN-13: 978-0198572220] (Probability Theory)
4. George B Thomas, Maurice D Weir, Joel Hass and Franke R Giordano, Thomas’ Calculus, 11 th Edition, Addison Wesley,
2004. [ISBN 9780321185587] (Calculus review)
5. Dennis G Zill and Micheal R Cullen, Differential Equations with Boundary Conditions, 7 th Edition, Cengage Learning, 2009.
[ASIN: B008UB1WJE] (Introduction to Differential Equations Overview)