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Lecture 1

This document provides an introduction and overview of a course on fundamentals of derivatives. It outlines the course requirements, including homework assignments and a final exam. The course will cover topics such as forwards, futures, swaps, and options. The goal is for students to understand how and why derivative markets are useful for hedging and speculation. Derivatives allow markets to set prices that provide information and allow traders to transfer risks, even if perfect hedging is not possible. A variety of participants, including hedgers, speculators, and arbitrageurs, trade derivatives.

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Sibyl Liu
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24 views

Lecture 1

This document provides an introduction and overview of a course on fundamentals of derivatives. It outlines the course requirements, including homework assignments and a final exam. The course will cover topics such as forwards, futures, swaps, and options. The goal is for students to understand how and why derivative markets are useful for hedging and speculation. Derivatives allow markets to set prices that provide information and allow traders to transfer risks, even if perfect hedging is not possible. A variety of participants, including hedgers, speculators, and arbitrageurs, trade derivatives.

Uploaded by

Sibyl Liu
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Fundamentals of Derivatives

Lecture One: Introduction

Savitar Sundaresan

Imperial College Business School

January 10, 2024


Introduction Housekeeping

Information

Email: [email protected]

Office: 5.01c, 53 Princes Gate

Office Hours: Wednesdays 9:30am-10:30am

(Optional) Textbook: Derivative Markets, 3rd edition by McDonald

(Optional) Recommended: Options, Futures, & Other Derivatives by Hull


Introduction Housekeeping

Course Requirements

Homework assignment (50% total)

Submitted by groups of four or five people:

Submitted via the Hub Feb 1st


Submitted via the Hub Feb 29th

Class Participation (0%)

Final Exam (50%)


Introduction Housekeeping

By The End of the Course:

You Should:

Understand the intuition and mechanisms behind derivative pricing.

Be able to discuss optimal derivative usage for hedging and speculation.

Understand why derivative markets are useful to non-derivative-traders.

You Will Not:

Have to memorize or derive complicated mathematical formulae.


Introduction Course Outline

Course Outline

Topic 1: Forwards and Futures

Topic 2: Swaps

Topic 3: Options (Basics)

Topic 4: Options (Advanced)

Topic 5: Credit Derivatives


Introduction Course Outline

TA Sessions

The course TA is Gulce Opuz.

TA sessions will be used to:

Solve sample exam questions

Work through derivations and class examples in more detail

Discuss and illustrate homework assignments.


Introduction Course Outline

How to Keep Pace

Notes for each topic.

Extra (optional) reading for each class.

Mentimeter questions and class participation.

Exam questions for each topic.


Introduction Course Outline

Miscellania

Lectures are recorded.

Slides will be made available before class.

Come to class and take notes - the slides are not a transcript!

There is a 5 - 10 min break in each class.


Introduction Course Outline

A Slide on Questions

If you have a question, others do too.

If you lose the thread, it is not always easy to recover it.

Don’t be afraid.
Introduction Course Outline

Outline for Today

What is a Derivative?

Why are they traded?

Applications
Introduction What is a Derivative

Definition

Definition: Derivative
A derivative is a financial instrument whose value is determined by other prices.

Forwards, Futures, Swaps, Options, CDS, etc.

Based on Stocks, Bonds, Commodities, Currencies, or even other Derivatives.


Introduction What is a Derivative

How Big is the Derivatives Market?

Global Equity Market Cap: $106 trillion (2023 - Sifma)

Global GDP: $105 trillion (2023 - IMF)

Global Bond Value: $133 trillion (2023 - Sifma)

Global (OTC) Derivatives Value: $713 trillion (2023 - ISDA)

Derivatives can exist on interest rates, equities, bonds, FX, etc.


Introduction Why are they useful?

What is the purpose of Financial Markets?

Setting prices.

Transferring risk.
Introduction Why are they useful?

Setting prices yields information

Investor uncertainty is high (options)

Fed is expected to raise interest rates (fed fund futures)

Ford has an X% probability of defaulting on its debt (CDS)


Introduction Why are they useful?

Risk and Hedging

Risks exist.

People are risk-averse.

People try to offset their own risks through trade.

But can you offset risks perfectly?


Introduction Why are they useful?

Arrow-Debreu Securities

Sunny + $1

t0 t1

1-p

Rainy - $1

How much would a security that pays $1 in the Sunny state cost?
How much would a security that pays $1 in the Rainy state cost?
Can I eliminate all risk?
Introduction Why are they useful?

Incomplete Markets

Our world has incomplete markets.

But derivatives start to fill in the gaps:

More sophisticated hedging

Better risk management

More targeted speculation


Introduction Why are they useful?

Who Trades

1 Hedgers (satisfy risks)

2 Speculators (use information)

3 Arbitrageurs (prices must follow some rules)

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