Course Outline

Department of Accounting and Finance

School of Business and Economics

FNCE 3180-01
Derivative Securities (3, 0, 0), Fall 2023

Instructor:Dr. Li Zhang Phone:(250)371-5612

Office: IB 2018 E-mail: lizhang@tru.ca
Office Hours: Mon & Thu: 2:00-3:30; or by appointment

Calendar Description

Students learn to value the main types of derivative securities and how to effectively utilize them in
risk management, asset speculation and financial engineering. Topics include an introduction to
forward and futures markets and hedging; mechanics of future markets; hedging with future
contracts; theoretical and forward prices; introduction to options; calculating option contract profits;
put-call parity and arbitrage bounds; option pricing models; exotic options; and swaps.

Educational Objectives/Outcomes

Upon completing this course, students will be able to:

1. Explain the mechanics of the futures and forward contracts.

2. Calculate profits or losses on future and forward contracts for hedgers and speculators.
3. Determine the futures prices for commodities and stock indices and describe how theoretical
upward and lower bounds impact possible prices.
4. Discuss the mechanics of options contracts and the markets they trade in.
5. Calculate theoretical option prices using one and two-stage binomial models, as well as under the
Black-Scholes model.
6. Demonstrate how put-call parity works in options markets.
7. Show how technical analysis can be used in a trading strategy for futures or options markets.
8. Assess the importance of interest rate and currency swap contracts in hedging.
9. Explain how credit default swaps potentially reduce risk.
10. Describe the characteristics of alternative derivative contracts such as weather derivatives,
energy derivatives, swaps, and exotic options.

Prerequisites

FNCE 2120 or FNCE 2121 or FNCE 3120 (grade of C+ or better); ECON 2330 or ECON 2331

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Co-requisites

None

Texts/Materials

Required: Hull, Fundamentals of Futures and Options Markets, 2017, 9th edition, Pearson.

Student Evaluation

Attendance 5%
Moodle Practice Sets 15%
End-of-Chapter Question Assignments 10%
Midterm 30%
Final exam 40%
Total 100%

 Students must pass the final exam with 50% or higher to pass the course, regardless of their
earned mark previous to the final exam.
 Last date to withdraw is October 27th.

In-Class Performance:
 Attendance: Students are required to attend all classes and are responsible for notifying
the instructor of absences before the day of the absence with supporting evidence and
get approval.
 Participation: Students are encouraged to participate in class discussions. Both frequency
and quality of participation will affect the assessment result.

Assignments: Assignments with end-of-chapter questions will be assigned in class. The

assignments are designed to ensure that students keep up with the lectures and discussions in
class and to help prepare for the exams. Assignments will be checked for completeness and will
not be marked. Solutions for the assignments will be posted on Moodle. If you have any
questions, it is important to ask in class or during office hours. Missed assignments cannot be
made up, and late assignment will be discounted by 30% per day.

Moodle Practice Sets: A set of practice questions will be given in Moodle every two to three
weeks. The questions are related to class discussions and are mostly randomized. Students can
use the questions to practice and prepare for the exams. Students can do the practice questions
as many times as they would like during the time the practice question sets are open. The
question sets are automatically marked, and for students who practice the questions several
times, the highest mark for each set will be retained for the calculation of the final grade.

Exams: The midterm will include all material covered in class before the exam. The final exam
FNCE 3180: Derivative Securities, Li Zhang Page 2 of 9
 will not be cumulative, but new material builds on topics previously covered and so concepts
from the mid-term exam may be found on the final exam. Missed exams will result in a zero
grade unless the absence is the result of a documented illness or family emergency. In those
cases, the instructor may assign the weight of the missed mid-term exam to the final exam. As
per departmental policy, the final exam must be passed in order to pass the course regardless of
the final grade point average. The final exam will be scheduled by the university during the
exam period. Time and date will be announced by the registrar office. Exam details will be
announced before the exams.

Final grades: Final grades will be determined based on the assessment weightings above and the
marks earned by students during the semester. It would be unfair and unethical for the
instructor to consider factors such as an individual student’s need to maintain a certain GPA,
graduation status, employment prospects, etc. During the semester, students are encouraged to
ask course-related questions and should inform the instructor immediately of any situations
that may impact their performance. Once final grades are posted, I will only discuss marking
errors in the final exam or errors in the calculation of the grades.

 Grading queries: Queries about the grading of an exam or assessment must be made
within one week from the date the exam or the assessment is returned. On request for
re-grading, the entire exam will be re-marked, which may result in the same, higher or
lower grade.

Philosophy: This course is fairly technical in nature and the extensive number of topics to be
covered requires that we move through the material at a fairly rapid pace. If you are having
trouble with the assignments, readings, or exams, please ask ASAP.

E-mail Etiquette: E-mail is often the quickest way to reach me outside the classroom. If you send
me an email, please include the course number and brief topic in the subject line, i.e., FNCE3180
section 1 chapter 4 question, and be sure to include your name, especially if you are not using
your MyTRU.CA email account. I will reply to the email account you used to send your query. I
may send class emails to your email account on file with the university, which is your MyTRU.CA
account by default, and will post important information to Moodle. I will expect you to be
aware of these messages so be sure to check your email and Moodle often.

Course Topics

1. An Introduction to Forward and Futures Markets and Hedging

 Forward contracts
 Futures contracts
 Option contracts
 Swap contracts

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  Other types of derivatives
 Hedging versus speculation
 History of derivative markets

2. Mechanics of Futures Markets

 Price quotations
 Opening and closing contracts
 Features of futures contracts
 Contract units, size, and asset specification
 Delivery dates
 Volume and open interest
 Long and short positions
 Profits and loss calculations
 Hypothetical profits from long and short positions

3. Hedging with Future Contracts

 Risks to be hedged
 Use of margin: initial and variation
 Short and long hedges
 Basis risk
 Cross hedging
 Minimum variance hedge ratio
 Hedging stock portfolios

4. Theoretical and Forward Prices

 Continuous versus discrete time approximation of theoretical price
 Pricing commodities
 Pricing stock index futures
 Pricing currency future
 Return on commodities
 Spreads
 Cost of carry and arbitrage bounds
 Futures arbitrage
 Discrete versus continuous approximation of bounds
 Introduction to technical analysis
 Trading strategies for future markets
 Fundamental analysis versus technical analysis
 Technical trading rules
 Support and resistance

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  Moving average rules
 RSI and channel rules
 Chart patterns
 Effectiveness of technical analysis: recent evidence

5. An Introduction to Options
 Mechanics of options markets
 Put and call options on stocks
 Strike price
 Stock price
 Option price
 Volume and open interest
 Profits and losses

6. Calculating Option Contract Profits

 Early exercise
 Graphing payoffs
 Put payoff
 Call payoff
 Combinations
 Straddles and strangles
 Bull and bear spreads
 Calendar spreads
 Butterflies and condors
 Strips and straps

7. Put-call Parity and Arbitrage Bounds

 Factors affecting option prices
 Put-call parity
 Upper and lower bounds on stock options
 Creation of synthetic securities
 Impact of dividends on option prices and bounds
 Bounds for current and index options

8. Option Pricing Models

 Binomial option pricing model
 Riskless portfolio
 Risk neutral valuation

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 One-stage binomial model
 Binomial model for calls
 Binomial model for puts
 Two-stage binomial model
 Black-Scholes option pricing model
 Lognormal distribution and model assumptions
 Inputs into the model
 Estimating historical volatility
 Implied volatility
 VIX index
 Greek letters and option prices
 Delta
 Gamma
 Theta
 Vega
 Rho

9. Exotic Options
 DerivaGem and online options calculators
 Definition of exotic options
 Binary options
 Forward start options
 Gap options
 Look back options
 Chooser options
 Asian options
 Shout options

10. Swaps
 Interest rate swaps
 Currency swaps
 Comparative advantage swaps
 Determination of swap rates
 Credit default swaps and exotic derivatives

Course Schedule

Course Topics Derivative Securities FNCE 3180-01

Mon & Thu 4:00-5:15 pm; OM2402

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 Week Readings Assignment /Notes
Class starts;
9/7
1 Chp 1. Introduction to Financial Derivatives Assignment
Chp 1. Introduction to Financial Derivatives
9/11
2 (cont’d) Assignment
9/14 3 Chp 2. Derivative Market Structure and Trading Assignment
Chp 2. Derivative Market Structure and Trading
9/18 4 (cont’d) Assignment
9/21 5 Chp 3. Hedging Strategies Using Futures Assignment
9/25 6 Chp 3. Hedging Strategies Using Futures (cont’d) Assignment
Chp 5. Determination of Forward and Futures
9/28 7 Prices Assignment
Chp 5. Determination of Forward and Futures
10/5 8 Prices (cont’d) Assignment
10/12 9 Chp 7. Swaps Assignment
10/16 10 Chp 7. Swaps (cont’d) Assignment
10/19 11 Midterm
10/23 12 Chp 9. Mechanics of Options Markets Assignment
10/26 13 Chp 9. Mechanics of Options Markets (cont’d) Assignment
10/30 10 Chp 10. Properties of Stock Options Assignment
11/2 14 Chp 10. Properties of Stock Options (cont’d) Assignment
11/6 15 Chp 12. Introduction to Binomial Trees Assignment
11/16 16 Chp 12. Introduction to Binomial Trees (cont’d) Assignment
11/20 17 Chp 13. Black-Scholes-Merton Model Assignment
11/23 18 Chp 13. Black-Scholes-Merton Model (cont’d) Assignment
11/27 19 Chp 11. Trading Strategies Involving Options Assignment
11/30 20 Chp 17. The Greek Letters Last class

Note: This is a preliminary schedule and is subject to change. Subjects covered each day will be
confirmed in class.

Honour Code

SOBE’s honour code states:

“As a student of the School of Business and Economics at Thompson Rivers University, I promise to act
honestly, ethically and with integrity. I accept responsibility for my own actions. I will not cheat, plagiarize, or
condone such behaviour in others.”

Academic Integrity
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 TRU Policy ED 5-0 Academic Integrity outlines the different types of infractions and the enforcement mechanisms
followed by the university. All students are encouraged to familiarize themselves with this policy to avoid committing a
violation.

Grading

TRU Policy ED 3-5 Grading Systems describes the grading system to be followed in all courses at TRU to help ensure the
comparability of grades across campus. Letter grades do not become official until they are approved by the Chairperson
responsible for the course and they subsequently appear on the student’s transcript. For undergraduate courses, the
letter grade system is:

Letter Grade Numerical Grade Points Letter Grade Definitions

Grade
A+ 90-100 4.33 Excellent. Superior performance showing comprehensive,
A 85-89 4.00 in-depth understanding of subject matter. Demonstrates
A- 80-84 3.67 initiative and fluency of expression.
B+ 77-79 3.33 Very Good. Clearly above average performance with
B 73-76 3.00 knowledge of principles and facts generally complete with
B- 70-72 2.67 no serious deficiencies.
Satisfactory. Basic understanding with knowledge of
C+ 65-69 2.33
principles and facts at least adequate to communicate
C 60-64 2.00
intelligently in the discipline.
Pass. Some understanding of principles and facts but with
C- 55-59 1.67
definite deficiencies.
Minimal Pass. A passing grade indicating marginal
D 50-54 1.00 performance. Student not likely to succeed in subsequent
courses in the subject.
Unsatisfactory. Fail. Knowledge of principles and facts is
F 0-49 0.00
fragmentary.
Did not complete the course, less than 50% of course
DNC 0.00 work completed or mandatory course component(s) not
completed. No official withdrawal.

Attendance

TRU Policy ED 3-5 Student Attendance states that students may be:

1. Removed from a course if they miss the first two classes without prior arrangements that are
acceptable to the instructor.
2. Refused admission to a course by the instructor for lateness, class misconduct, or failure to complete
required work.
3. Removed from a course by the instructor for deficient attendance without cause with the permission of
the instructor’s Chairperson or Dean.

Methods of Prior Learning Assessment

TRU recognizes that learners acquire knowledge and skills through life and work experience in addition to formal
academic study. TRU Policy ED 2-0 Prior Learning Assessment and Recognition outlines the procedures that the

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 university will follow in assessing this knowledge and skills for potential credit.

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