MGFC30H -- Introduction to Derivatives Markets
Instructor:
Office:
Office hrs:
Phone:
Prof. Jason Z. Wei
IC 372
MO 3-4:30pm, WE 5-6pm
416-287-7332
Sept. – Dec., 2018
L01: WE 12-2pm, IC 208
L02: WE 3-5pm, IC204
Email: wei@utsc.utoronto.ca
COURSE DESCRIPTIONS
Derivatives, as a class of financial securities, have become an integral part of modern
finance. Nowadays, introductory and intermediate-level courses on futures and options are standard
offerings in most business schools. Meantime, the demand for finance professionals with a sound
understanding of derivative products and markets has been increasing, especially on Wall Street
and Bay Street. Financial institutions (e.g., banks) and institutional investors (e.g., pension funds)
regularly deal with the trading, valuation, and accounting of derivative securities. The co-op terms
of many UTSC BBA students involve duties related to derivatives, especially for the placements
with banks, CPPIB and Ontario Teachers’ Pension Plan.
This course covers the fundamentals of futures and options, with four main objectives. First,
it introduces students to the basic valuation models such as the cost-of-carry model and the BlackScholes model. Just as the discount cash flow framework allows us to value bonds and stocks (by
discounting coupons and dividends), the basic valuation models introduced in this course allow us
to arrive at an intrinsic value for a derivative security. Second, we demonstrate how derivative
securities can be used to enrich investment strategies and enhance risk management (e.g., portfolio
insurance). Third, the course exposes students to the most recent developments in the derivatives
market, and identifies trends that will likely shape the future of the derivatives industry. Fourth,
the course enlightens students with the practical aspect of the derivatives markets. Through realtime trading of derivative securities via the Rotman Portfolio Manager (RPM), students will be
able to apply their classroom knowledge to real-world investing. By the end of the course, students
will have mastered the basic knowledge and skills necessary to pursue an entry level career in the
derivatives industry or pursue advanced studies of the subject.
The co-requisite is MGFC10 (Intermediate Finance) and hence the prerequisites are
identical to those of MGFC10. Those who have taken RSM435H (Futures and Options Markets)
on St. George Campus or MGT438H from UTM are not allowed to take this course.
Management, 1265 Military Trail, Toronto, ON, M1C 1A4, Canada
www.utsc.utoronto.ca/mgmt
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REQUIRED TEXTBOOK:
Fundamentals of Futures and Options Markets, 9th Edition, by John Hull (Pearson, 2017). ISBN10: 0-13-408324-5, or ISBN-13: 978-0-13-408324-7.
PERFORMANCE EVALUATION:
Attendance:
Assignments (3):
Simulation:
Report:
6%
Portfolio:
4%
Bonus:
2%
Mid-term exam:
Final exam:
3%
12%
10%
25% (Date: Oct. 24 - Temporary)
50%
The following notes apply to the above evaluation scheme. First, no late assignments will
be accepted for marking since the solutions are posted right after the deadline.
Second, although only three assignments are to be handed in for marking, one extra
assignment will be given for practice. Only Assignments 1, 3 and 4 are for marking. Assignment 2
is for practice only. Students do not have the option of handing in any three of the four assignments.
You must hand in Assignments 1, 3 and 4.
Third, for those who fail to write the midterm exam, the midterm weight (25%) will be
added to the final exam (75% in total). There will be no makeup midterm exam.
Fourth, to encourage continuous efforts and to reward significant improvement in
performance throughout the course, the midterm exam weight will be partially shifted to the final
exam should the final exam turn out to be better than the midterm. The bigger the improvement,
the larger the amount of shift in weight. If the percentage improvement is larger than 30%, then all
the midterm weight of 25% will be shifted to the final. Specifically, let “m” and “f” stand for the
midterm and final marks respectively in percentage and suppose f > m. Then the amount of shift =
[min(f – m, 0.30)/0.30]3/2 × 25%. For instance, if the final is 82% and the midterm is 61%, then the
shift is [0.21/0.30]3/2 × 25% = 14.64%. In this case, the midterm is worth 10.36% and the final is
worth 64.64%. To continue the example, if the final is 86% or higher, then the entire midterm
weight is shifted to the final.
Finally, the purpose of assigning 3% of the course weight to attendance is to discourage
students from skipping classes. Past experiences indicate time and again that the consequence of
missing classes is far more detrimental than students would like to believe. Barring unforeseen,
extraordinary events, students should attend each and every lecture. Attendance will be taken at
least three times throughout the term, with dates to be randomized. Each absence will result in a
loss of 1%, and the total penalty will be capped at 3%. For instance, if attendance is taken four
times in the term, and a student is absent at each attendance check, then he/she will lose 3%. On
the other hand, if attendance is taken five times, and a student is present at the first three attendance
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checks and only absent at the last two checks, then he/she will still lose 2%. In other words, I count
the total number of absences.
Given the limited lecturing hours, it is very difficult to cover in detail all the relevant topics
in class. To better utilize the classroom time, students are encouraged to come prepared for each
lecture by reading ahead. Active learning in the form of pre-class reading and in-class questioning
is extremely beneficial. Class participation is encouraged.
SELF-STUDY AND REVIEW
Aside from reading ahead, students are also encouraged to review each lecture right after
the class and clear away all the questions before the next lecture. The benefits are enormous. To
facilitate this process, end-of-chapter questions will be assigned to each topic, in addition to the
many in-class numerical examples. Full solution keys are provided for all assigned questions.
Students are encouraged to fully utilize the office hours offered by the TA and the instructor.
COMMUNICATIONS AND COURSE MATERIAL DISTRIBUTIONS
All of the study materials including assignments and important announcements will be
posted on the portal. Students are encouraged to frequently check the postings.
SIMULATION — RPM INVESTMENT CHALLENGE
The ultimate purpose of the simulation is to introduce realism in learning. A group of nomore-than six students will perform the task of setting up and managing a derivatives portfolio
(students may also form smaller groups as they wish, but the minimum size should be two).
Through trading derivatives on formal exchanges, students are expected to learn and appreciate the
workings of the derivatives markets, and to apply their knowledge and wisdom in the investment
world. The investment vehicle will be the Rotman Portfolio Manager (RPM). Please visit
http://rpm.rotman.utoronto.ca for details. Please also download the RPM advanced user guide:
http://financelab.rotman.utoronto.ca/documents/RPM_Students_Advanced_User_Guide.pdf. Be
sure to read it before the simulation starts. For a quick-start guide, please download:
http://financelab.rotman.utoronto.ca/documents/RPM_Students_Quick_Start_Guide.pdf.
(The
two files are also available on the portal.) There are a 15 minute-long Quick Start Tutorial video
for first-time users and a 60 minute-long full video explaining the software features.
The investment game will start on September 24, 2018 (Monday) and end on November 23,
2018 (Friday), for a duration of nine weeks. Each account will be endowed with $1,000,000Cdn
fake money, and participants will have access to stocks (North American as well as international),
options, futures, futures options, bonds, and currencies. In this simulation, students are required
to trade only derivatives: options, futures and options on futures.
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There will be two training sessions offered by the Finance Trading Lab, one on Monday,
September 17 and the other on Wednesday, September 19. The two sessions are identical and run
from 5:30pm to 6:30pm. Students may choose the session at their convenience. The training session
is essential since it will teach you the basics of derivatives trading and prepare you for the start of
simulation on September 24. Everyone should attend regardless of your group size. We will take
attendance and a 1% bonus will be offered to those who are present. For your convenience, the
Finance Trading Lab has created a resource page: http://guides.library.utoronto.ca/MGFC30.
Overall Instructions and Requirements
Each group will maintain a trading account with an initial endowment of $1,000,000Cdn.
Students are allowed to trade derivatives only. The position limit is 50%, meaning that you cannot
invest more than 50% of your capital in a single security. All groups will be subject to the same
investment restrictions set out by RPM. Specifically, transaction costs are $2/contract for futures
and options. The borrowing and lending rates are, respectively, 0.5% above and 0.5% below the
overnight LIBOR rate.
To register your account, follow these steps:
1.
Download and install the software from http://rpm.rotman.utoronto.ca/
2.
Form your group and submit your group membership to me, with each member’s
name, student number, email, and phone number (deadline is September 18).
3.
Register your group account on the following webpage:
http://rpm.rotman.utoronto.ca/. The Class Code is MGFC30_2018f, and the Class
Password is “hedgefund.” Please don’t register more than one account per group.
Note: no adjustment will be made to group membership once finalized on September 18.
You must make up your mind beforehand. This is especially important for those who want me to
assign you to a group (i.e., I form a group for you). Please indicate your preference (if any)
beforehand. Do not come back to me and ask for group re-assignment after the September 18
deadline.
You will be evaluated based on two items: a written report (6%) and the ending portfolio
value (4%). Clearly, much more weight is placed on the report, since students are not supposed to
be overly concerned about the portfolio value. The written report should be no more than six pages
long (excluding tables, figures, etc), double-spaced, and in regular sized fonts. There is no specific
format required for the report. However, a good report will clearly stipulate the investment
objective and corresponding strategies; discuss the implementation of the strategies; justify the
strategies with respect to the assessment of the market conditions (e.g., gold price movements);
provide insights gained from the simulation; and so on. A group may in the end lose a lot of money,
but if it can clearly justify its objectives and strategies and implement meaningful trades, then the
group can still get a high mark on the report. In other words, in the end, it is the experience and
learning that count.
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To make the simulation more exciting, 4% is assigned to the portfolio value. Here, the
objective is very simple: get the highest return possible. The evaluation is purely based on portfolio
value, regardless of the strategies. The 4% is to be awarded to the best performing portfolio, but I
do have my own bar set for this, and it is going to be subject to my sole discretion. For instance, if
the best performing portfolio in our class earns only a 7% return, then I will be very hesitant to
give 4% to this group. Notice that I do not set an absolute bar. This is in the students’ interest,
because I am not prepared to give a zero to any group.
Finally, to reward superior performance, a 2% bonus will be handed out if the ending
portfolio is above $4,000,000. For instance, if a group gets a perfect mark on the report, and has an
ending portfolio value of $4,500,000, then it will receive 12% from the simulation. Note: the bonus
is handed out ONLY WHEN the portfolio value is above $4,000,000. In other words, you won’t
get it or a fraction of the bonus if your ending portfolio value is, e.g., $3,950,000.
The following are specific requirements:
1) Complete account registration and make at least one transaction by the end of
September 25. Failure to do so will lead to a loss of 1%, regardless of the final
portfolio performance.
2) Make at least five (5) transactions by the end of week 4 (i.e., October 19). Failure
to do so will lead to a loss of 1%, regardless of the final portfolio performance.
3) Make at least 12 transactions by the end of week 6 (i.e., November 2). Failure to do
so will lead to a loss of 1%, regardless of the final portfolio performance.
(Therefore, you may actually lose 3% toward your total course grade if you fail to
meet all of the three requirements.)
4) Execute a minimum of 20 transactions by the end of the simulation. When/if this
condition is not met, the group will receive a zero for the simulation even if the
group has met requirements 1) to 3).
Several caveats are in order:

Portfolio performance will be based solely on the closing value at the end of the
simulation. The history of portfolio performance does not matter as far as the 4% is
concerned. But the history will matter for your report. For instance, if your portfolio
has been doing well until the last week when a big mistake makes a devastating
blow to your portfolio, I still consider that you have done well overall.

Please do not exercise options since you will end up with a stock position, but you
are not allowed to trade stocks in this simulation. You should sell the options if you
want to close the position.
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Several popular resources for stock analysis and trading strategies:

http://www.barchart.com

http://www.marketwatch.com

http://www.bnn.ca/
Enjoy and good luck!!!
Resolution of Team Work Conflict
Once in a while, I receive complaints from students that certain of their group members are not
shouldering their share and hence not contributing enough to the group. In all cases, I leave the
resolution to the group, for managing group dynamics is part of the learning. To facilitate a
successful resolution in case of dispute, I have borrowed the idea of Peer Evaluation from a
colleague. Please see the Peer Evaluation Form at the end of this course outline. Of course, only
those groups that have an issue with uneven workload (perceived or real) may consider filling out
the form. Note: the form is valid only with signatures from all members of the group.
Academic Support
The Department of Management, in collaboration with the UTSC library, will be providing
academic research support in the IC Building. To refine your research skills or to learn more
about various scholarly resources, please contact the Librarian for Management and Economics
students.
Stephanie Perpick
Librarian, Department of Management IC368
416-208-2987
Stephanie.perpick@utoronto.ca
Office hours by appointment
The English Language Development Centre (ELDC) helps students develop the critical thinking,
vocabulary and academic communication skills essential for achieving academic and professional
success. Personalized support includes: RWE (for academic writing); Communication Cafés
(oral); Discussion Skill-Building Cafés; Vocabulary Cafés; seminars/workshops; personal ELD
consultations; drop-in sessions. http://ctl.utsc.utoronto.ca/eld/
The Writing Centre (TWC) offers invaluable services to students (learn to become a better
writer!) and offers many different kinds of help: drop-in sessions, individual consultations,
workshops, clinics, and online writing handouts. http://ctl.utsc.utoronto.ca/twc/
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Academic Misconduct
Students should note that copying, plagiarizing, or other forms of academic misconduct will not be
tolerated. Any student caught engaging in such activities will be subject to academic discipline
ranging from a mark of zero on the assignment, test or examination to dismissal from the university
as outlined in the academic handbook. Any student abetting or otherwise assisting in such
misconduct will also be subject to academic penalties.
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PLANNED COURSE SCHEDULE
Topic
I.
INTRODUCTION
−
−
II.
III.
IV.
V.
Sept 12, 19, 26
2, 3, 4, 5, 6
Oct 3, 17
9, 10, 11
Basics
Trading Strategies
Factors Affecting Option Prices
Bounds for Option Prices
Early Exercise of American Options
Oct 24
BINOMIAL TREES
Oct 31
12, 18
Nov 7, 14
13, 15, 16
17
Nov 21
22, 23, 24
−
−
−
−
−
One Period Binomial Tree
Two-Period Binomial Tree
Multi-Period Binomial Tree
Binomial Tree for Options on
Indexes, Currencies and Futures
−
Binomial Tree for a Dividend Paying Stock
THE BLACK-SCHOLES MODEL
History
Review of Probability Theory
Modelling Stock Price
The Black-Scholes Model
EXOTIC AND INNOVATIVE OPTIONS
−
−
−
−
−
−
−
−
−
−
VII.
1
Mid-Term Exam
−
−
−
−
VI.
Sept 5
Definitions
Purpose of Futures Markets
Structure and Specification of Futures Contracts
Operation of Margins
Forward and Futures Price Determination
Interest Rate Futures
Hedging with Futures
OPTION TRADING STRATEGIES AND
PROPERTIES OF STOCK OPTIONS
−
−
−
−
−
Chapter
Introduction
Risk versus financial engineering
FORWARDS AND FUTURES
−
−
−
−
−
−
−
Date
Range-forward contract
Chooser option
Barrier option
Look-back option
Shout option
Asian option
Option to exchange one asset for another
Innovative swaps
Credit derivatives
Weather derivatives
APPLICATIONS AND REVIEW
Nov 28
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Detailed Outline and Pages of Text Corresponding to Each topic
Topic
I.
Pages
INTRODUCTION
−
−
1-19
Introduction
Risk versus financial engineering
Quiz: 1.1, 1.2, 1.3, 1.4, 1.6.
II.
FORWARDS AND FUTURES
−
−
−
−
−
−
−
Definitions
Purpose of Futures Markets
Structure and Specification of Futures Contracts
Operation of Margins
Forward and Futures Price Determination
•
Preliminaries
•
Cost of Carry Model
•
Forward on a Security without Cash Income
•
Forward on a Security with Known Cash
•
Stock Index Futures
•
Forward and Futures on Currencies
•
Futures on Commodities
•
Futures Price as a Predictor of Future Spot Price
Interest Rate Futures
•
Preliminaries
•
Forward Rate Agreement (FRA)
•
Treasury Bill Futures
•
Day Count Conventions
•
Treasury Bond Futures
Hedging with Futures
•
General Issues
•
Optimal Hedge Ratio
1-7
24-27
29-35, 217-218
81-91
127
107-112
113-118
63-69, 118-120
121-124
124-127
118, 128-130
81-92
95-97
(Not in book)
136-138
139-143
49-55
60-62
Quiz: 2.1, 2.5, 3.1, 3.3, 3.5, 4.1, 4.5, 4.7, 5.2, 5.5, 5.6, 5.7, 6.1, 6.2.
III.
OPTION TRADING STRATEGIES AND
PROPERTIES OF STOCK OPTIONS
−
−
−
−
−
Basics
Trading Strategies
•
single option holdings
•
straddle
•
strip
•
strap
•
strangle
•
bull spread
•
bear spread
•
butterfly spread
Factors Affecting Option Prices
Bounds for Option Prices
Early Exercise of American Options
•
without dividends
•
with dividends
202-215
249-253
261-262
262-263
262-263
263-264
253-255
255-256
258-259
227-230
232-239
239-243
243-245
Quiz: 9.1, 9.4, 9.6, 10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 11.2, 11.3, 11.6.
9
Detailed Outline and Pages of Text Corresponding to Each topic
Topic
IV.
Pages
BINOMIAL TREES
−
−
−
−
−
One Period Binomial Tree
Two-Period Binomial Tree
Multi-Period Binomial Tree
Binomial Tree for Options on
Indexes, Currencies and Futures
Binomial Tree for a Dividend Paying Stock
268-274
274-281
281-282, 391-398
398-401
401-404
Quiz: 12.1, 12.3, 12.5, 18.2, 18.3.
V.
THE BLACK-SCHOLES MODEL
−
−
−
History
Review of Probability Theory
Modelling Stock Price
•
Black-Scholes assumption of returns
•
expected return
•
estimating volatility
•
The Black-Scholes Model
•
assumptions
•
model
•
Black-Scholes model with dividends
•
options on stock indexes
•
options on currencies
•
futures options
•
delta and delta hedging
•
insurance with traded put options
•
insurance with synthetic put options
•
insurance with index futures
293
(Not in book)
294-296
297-298
298-301
301-302
304-306
309-311
328-331, 333-335
331
344-348, 350-354
359-364
(Not in book)
382-385
383-384
Quiz: 13.2, 13.4, 13.5, 13.6, 15.1, 15.2, 15.6, 16.3, 17.1, 17.2, 17.3, 17.7.
VI.
EXOTIC AND INNOVATIVE OPTIONS
−
−
−
−
−
−
−
−
−
−
Range-forward contract
Chooser option
Barrier option
Look-back option
Shout option
Asian option
Option to exchange one asset for another
Innovative swaps
Credit derivatives
Weather derivatives
332-333
480
480-482
482
482-483
483
483
485-491 (only casual read)
496-500, 505-507
515-520
Quiz: 22.1, 22.3, 24.1, 24.2.
VII.
APPLICATIONS AND REVIEW
1-598 : -)
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Peer Evaluation Form for Workload/Credit Redistribution
This form is to facilitate a negotiated settlement among group members when dispute arises
concerning relative workload and contribution. It is modelled after similar forms used in some
other Management courses.
It is recommended that the group meets as soon as some members are perceived/believed to shirk.
Very often, the meeting itself with frank discussions can clear the issue (e.g., the perceived shirking
may simply be due to some misunderstanding/miscommunications or special personal
circumstances). At any rate, if all members agree that the workload is not evenly distributed, then
the form may be signed with credit redistribution. Each group member is endowed with 100 points
and the redistribution will lead to a re-scaling of the group grade. All members must sign the form
in order for it to be effective.
To illustrate, suppose there are five members in the group and the group receives 80% on the project.
Further suppose that Member A in the group agrees to receive only 70% of the group grade since
he/she failed to contribute enough. In this case, A’s mark will be (0.7)80% = 56%, while that for
other four members will be (430/4)80% = 86%. To avoid an adjusted mark exceeding 100%, the
scaled-up mark will in general be max{100%, G(100n–S)/(n-m)}, where G is the group project
grade, n is the group size and S is the total points among the m shirking members. To illustrate
further, suppose the group receives 90% on the project and suppose A agrees to lose 20 points and
B agrees to lose 30 points, then the marks for A and B will be (0.8)(90%) = 72% and (0.7)(90%) =
63%, while the mark for the remaining three members will be max{100%, 90%(500–150)/(5–
2)}=max{100%, 105%} =100%.
Name
Points
Signature
Total points 
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