Financial Innovations FALL 2007 Department of Finance National Taiwan University Instructor: Dr. San-Lin Chung Office: Room 707, Building 2, College of Management Phone: 33661084 Email: [email protected] Class hours: Thursday 2:20 pm – 5:20 pm Office hours: by appointment Course Objective: Financial innovations can be broadly divided into two parts: product innovations and process innovations. This course will mainly focus on the financial product innovations. This course is to expose students to general design principles, pricing, risk management, and practices of financial product innovations in Taiwan and of international transactions. The detailed topics covered in this course are as follows: 1. Introduction to financial innovation The evolution of risk management products Impact of the introduction of the risk management products 2. risk management of derivatives Dynamic hedge Static hedge Risk measures: Value at risk, scenario analysis, standard deviation 3. Analytical tools Binomial methods Monte carlo simulation method Models, estimations, and model risk 4. exotic options (Asian option, lookback option, barrier option, exchange option) 5. swaps revisited (asset swap, equity swap, differential swap, cross-currency swap) 6. credit risk and credit derivatives 7. Weather, energy, and insurance derivatives 8. volatility derivatives 9. structured notes 10. How to implement risk management in the real world? (invited speaker: senior risk manager of Fubon bank) After this course, the students are expected to be able to analyze a complex financial product such as structure notes. At the end, every student needs to choose one product from the list (TBA) to make his or her final report. This syllabus can be downloaded from my website: http://www.fin.ntu.edu.tw/~slchung/ Grading: The course grades will be based on the following elements: Exercises and summarized report Final report Presentations and Participations 30% 40% 30% Topics and Reading lists: 1. Introduction to financial innovation Smithson, C. W., 1998, Managing Financial Risk, Chap 1 & 3, 3rd Edition, McGraw-Hill International. Tufano, P., 2002, Financial Innovation, working paper, Harvard Business School. 2. risk management of derivatives Hull, J. C., 2005, Option, Futures, and Other Derivatives, Chap 15 & 18, 6th Edition, Pearson Education. Smithson, C. W., 1998, Managing Financial Risk, Chap 18 & 19, 3rd Edition, McGrawHill International. Carr, P., K. Ellis, and V. Gupta, 1998, “Static Hedging of Exotic Options,” Journal of Finance, 53, 1165-1190. Derman, E., D. Ergener, and I. Kani, 1995, “Static Options Replication,” Journal of Derivatives, 2, 78-95 Ju, X., and N. Pearson, Using Value at Risk to Control Risk Taking: How Wrong Can You Be?, Journal of Risk, 1, 5-36. 3. Analytical tools Hull, J. C., 2005, Option, Futures, and Other Derivatives, Chap 17, 19, & 24, 6th Edition, Pearson Education. 4. Exotic options Hull, J. C., 2005, Option, Futures, and Other Derivatives, Chap 22, 6th Edition, Pearson Education. Chung, S. L., 2002, Pricing American Options on Foreign Assets in a Stochastic Interest Rate Economy, Journal of Financial and Quantitative Analysis, Vol. 37, No. 4, 667-692. 5. Swaps revisited Hull, J. C., 2005, Option, Futures, and Other Derivatives, Chap 30, 6th Edition, Pearson Education. Chang, C. C. and S. L. Chung, 2002, Pricing Asian-Style Interest Rate Swaps, Journal of Derivatives, Vol. 9, No. 4, 45-55. Chang, C. C., S. L. Chung, and M. T. Yu, 2002, Valuation and Hedging of Differential Swaps, Journal of Futures Market, Vol. 22, No. 1, 73-94. Chung, S. L., and H. F. Yang, 2005, Pricing Quanto Equity Swaps in a Stochastic Interest Rate Economy, Applied Mathematical Finance, 12(2), 121-146. Smithson, C. W., 1998, Managing Financial Risk, Chap 9, 3rd Edition, McGraw-Hill International. Smith, D. J., 1997, Aggressive Corporate Finance: A Close Look at the Procter and Gamble – Bankers Trust Leveraged Swap, Journal of Derivatives, 4, 4, 67-79. 6. Credit risk and credit derivatives Hull, J. C., 2005, Option, Futures, and Other Derivatives, Chap 20 & 21, 6th Edition, Pearson Education. Hull, J. C., and A. White, 2004, Valuation of CDO and nth-to-Default Swap without Monte Carlo Simulation, Journal of Derivatives, 12, 2, 8-23. 7. Weather, energy, and insurance derivatives Hull, J. C., 2005, Option, Futures, and Other Derivatives, Chap 23, 6th Edition, Pearson Education. 8. volatility derivatives handout (PowerPoint file) Demeterfi, K., E. Derman, M. Kanmal and J. Zou, 1999, A Guide to Volatility and Variance Swaps, Journal of Derivatives, 6, 4, 9-32.