BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE, Pilani

Pilani Campus
AUGS/ AGSR Division

Course Handout Part II

Date: 12/08/2023

In addition to Part-I (General Handout for all courses appended to the timetable) this portion gives further
specific details regarding the course.

Course No. : ECON F354 / FIN F311

Course Title : Derivatives & Risk Management

Instructor(s) : Dr. Rajan Pandey & Dr. Byomakesh Debata

Instructor-in-charge : Dr. Byomakesh Debata

1. Scope & Objective:

The objective of this course is to provide students an introductory level familiarity with a particular type
of financial instruments known as DERIVATIVES. To achieve the stated objectives, the course
provides a detailed description on the structure (read, design) and utility (read, relevance) of the most
common and popular financial derivatives namely, Options, Futures, and Swaps. The scope of the
course entails acquainting students with the mechanics of trading and settlement of derivative
instruments in the financial markets and their function as insurance products for hedging financial risk.

No understanding about financial instruments or their derivatives is complete without a thorough grasp
over interest rate concepts and hence the course also includes discussion on topics such as time value
of money, term structure of interest rates and their role in valuation of bonds, computation of yield
and forward interest rates, estimating bond-price volatility, and the role of bond duration and
convexity in mitigating interest rate risks.

The topics covered in the course will, at an introductory level, enable participants to learn about
common risks prevalent in the financial markets and how to manage its impact on investment exposure
by using derivatives. Discussion on valuation of financial derivatives and a brief introduction to
creating synthetic investment positions by combining derivatives prepares students for advanced level
courses such as Financial Engineering and Financial Risk Analytics and Management. The course
concludes with a survey of selective topics of contemporary interest to risk management industry such as
forecasting volatility, estimating value-at-risk, etc. The topics covered in the course will also assist
students in preparing for competitive professional international certifications such as Financial Risk
Manager (FRM) and Chartered Financial Analyst (CFA).

2. Prerequisites: This is an elementary course on Derivatives and Risk Management and does not assume
any prior knowledge of Financial Markets, Instruments and Derivatives. However, familiarity of basic
economic theory such as law of supply and demand, utility maximization principle, compounding and
discounting of cash flows, etc. are desirable. The course is not mathematically rigorous and a first-year
course on elementary linear algebra, calculus, probability, and differential equations will be sufficient to
grasp the contents of the course. It is expected that students have technical know-how of MS excel as it
will be used to demonstrate required computations, wherever required, and for carrying out take-home
assignments.

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE, Pilani
Pilani Campus
AUGS/ AGSR Division

3. Text book:
Hull, John C., and Basu, Sankarshan (2016). Options, Futures, and Other Derivatives, 10th Edition. Pearson Education
Inc.

4. Reference books:
➢ R1. David A. Dubrofsky and Thomos W. Miller, Jr., Deivatives Valuation and Risk
Management, Oxford Unversity Press.

➢ R2. David G. Luenberger, Investment Science, Oxford University Press

5. Course Plan:
Lecture Learning Objectives Topics to be Covered Learning Outcomes Reading
No. and Reference
Date
1 Orientation: Understanding of course contents
• Course introduction and -NA- and their significance -NA-
discussion on the hand-
out.

2-4 Time Value of Money Concept of interest, Calculation of • Should be able to understand Class
interest, Time value of money, application and various methods Notes
present value, and future value of interest,
• Familiarity about application of
interest rate in real world.
5-6 Introduction: • Exchange-traded markets vs. • Basic understanding of type of Ch. 1
• Introduction to Financial Over-the-counter markets. markets, market participants and (selective
Markets and financial • Introduction to common financial instruments topics:
instruments. instruments such as stocks and follow
• Role of intermediaries in bonds, and their role in financial classroom
modern-day finance. markets. discussion)
• What are derivatives and • Basics of derivatives and the + Class
their relation with concept of the underlying notes
traditional financial instrument.
instruments? • Distinction between
• Types of traders in investment, hedging, and
financial markets. speculation.
• Role of arbitrageurs in financial
markets.

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE, Pilani
Pilani Campus
AUGS/ AGSR Division

7-9 Basic Tenet: An introduction to: • Understand the significance of Ch. 4 +

• Introduction to types of • What is risk? How to estimate risk-return tradeoff class
risks present in the risk? • Role of Derivatives in risk notes
financial markets. • What is return? How to management
• What is return on estimate return on stocks? • Basics of fixed income securities
investment and how is it • Historical analysis of financial
calculated? instruments from their risk-
• How derivatives are used return profiles.
in managing downside risk?
• Fixed income instruments
and their Derivatives

10-17 Futures and Forwards • Specification of a futures • Identify futures contract on stock Ch. 2 and 3
contract. exchange and read and interpret + Class
• Introduction to Futures • Trading of futures contract on online quotes on futures. note
• How Futures are traded on stock exchange. • Place trading orders on
stock exchange? • Margin requirements and Futures.
• Clearing and settlement marking-to-market futures • Importance and implications of
of Futures contract. position. margin requirements for
• Risk management • Expiration of futures initiating a futures contract and
strategies using contract and rollover. role of maintenance margin in
futures. • Basic trading strategies using sustaining the contract.
• Forwards contract futures contract. • Identification of variables that
• Hedging stock risk using
• Valuationof Futures affect intra-and-inter- day prices of
futures contract. futures contract.
and Forwards.
• Law of convergence and • Role of interest rates,
valuation of futures contract. transportation costs, storage costs
• Forwards vs Futures on prices of futures.
• Cost of carry and its
• Risk management using
implication on futures
futures contract.
valuation.
• Speculation using futures
contract.
• Forwards on non-financial
assets (commodities).
• Stock index futures.

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE, Pilani
Pilani Campus
AUGS/ AGSR Division

18-25 Options: Introduction, • Types of options. • Distinction between Ch. (10, 11

Trading, Strategies • Options positions and long on options and ,12) +
basic pay-off diagrams short on options. Class
• Introduction to options • Specification of options • Draw pay-off notes
• Difference between and interpretation of diagrams of different
options and futures. options quotes options based
• Options trading • Market mechanics of strategies.
options trading, clearing, • Interpretation of price of
mechanism, clearing
and settlement. an option as function of
and settlement of
options. • Factors affecting intrinsic value and time
options prices. value.
• Identify important
• Stock position • Impact of moneyness of
variables that impact
protection using an option on its value and
options prices.
options. utility for hedging the
• Options strategies for
• Creating spreads, net underlying.
risk management and • Creating hedging
debit and net credit
speculation. strategies using options.
strategies, anticipation
based strategies, volatility
based strategies.

26-33 Option Valuation • What is moneyness of an • Differentiate between At-the- Ch. 11

• Put-call Parity and option and its role in option money, In-the-money, and Out- (selective
option valuation. valuation and creating of-the-money options. topics), 19,
• Binomial model of strategies? • Identify mispricing of options 13, 15 +
option pricing. • Moneyness and delta using Put-Call parity. Class
• Learn the theory of risk- notes
• Black-Scholes-Merton hedging.
(B-S-M) option pricing • One-step binomial model and a neutral valuation and use
model. no-arbitrage argument. Binomial and B-S-M model to
• Risk-neutral valuation. price options using data from
• Two-step binomial trees the stock exchange.
• Binomial model: Simulation • Learn the impact of dividends on
example. option prices.
• Bounds for option prices.
• Put-call parity and no-
arbitrage condition.
• Inputs to Black-Scholes-
Merton option pricing model.
• Estimation of call and put
prices using B-S-M model.

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 BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE, Pilani
Pilani Campus
AUGS/ AGSR Division

34-36 Swaps and their applications • Mechanics of swaps. • Why firms undertake swaps Ch. 7 +
• Need for swaps in • Comparative-advantage contract for exchanging one cash- class notes
modern day finance. argument. flow with another?
• Different typesof • Valuation of interest rate • How swap contracts are
swaps. swaps. designed and what purpose they
• Role of financial satisfy?
institutions in a swap • Role of financial
contract. intermediaries in a swap
contract.
• Distinction between different
types of swaps.

6. Evaluation Scheme:
Components Weightage Date & Time Nature of component
(%) (Close Book/ Open Book)
Mid-Semester Test 35% As per time-table Close Book/Open Book
Comprehensive 45% As per time-table Partly Open Book
Examination
Quizzes (2) 20% TBD -

7. Learning outcome

This course is designed to enable the students to understand and learn:

I. Basics of derivative instruments, markets, and risk management
II. Forward and futures contracts, pricing, and basic applications in hedging
III. Option contracts, trading strategies, pricing models, and basic applications in hedging
IV. Interest rate and currency swaps, and forward rate agreements

Make-up policy
No make-up will be given for tests without prior approval from the I/C. Make-up for comprehensive exam will be decided by
AUGSD. Only genuine cases will be considered for make-up. Kindly note that there is no buffer quiz.

Chamber Consultation Hour: Thursday- from 4:30PM to 5:30 PM.

Notices: Notices concerning the course will be intimated online/displayed in Departmental notice board.

Instructor in-charge
Dr. Byomakesh Debata

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