This course develops the basics of derivative security pricing. We cover both simple derivative contracts, such as forward, futures, and swaps, as well as more complex derivatives, such as put and call options and credit derivatives. The focus of the course is on the pricing and hedging of derivative securities through the principles of no-arbitrage and the law of one price. We apply these concepts to dynamic trading models, through the development of the binomial tree model, the Black-Scholes option-pricing model, and the risk neutral pricing methodology. We discuss several important applications of the pricing methodology, such as its implications for risk management, exotic options, the pricing of corporate securities (corporate bonds, callable bonds, equity, etc.), credit derivatives, and real options for investment decisions. We also discuss the role of arbitrageurs in ensuring no arbitrage, and use the 2007 – 2009 crisis also to highlight what happens to the law of one price if arbitrageurs are short in capital.
The course is analytical in nature, requiring some prior exposure to calculus, statistics, and probability theory.
Class materials such as problem sets, lecture slides, and other information will be posted on Canvas.
