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2017/2018  KAN-CMECV1701U  Fixed Income Derivatives: Risk Management and Financial Institutions

English Title
Fixed Income Derivatives: Risk Management and Financial Institutions

Course information
Language English
Course ECTS 7.5 ECTS
Type Elective
Level Full Degree Master
Duration One Semester
Start time of the course Spring
Timetable Course schedule will be posted at calendar.cbs.dk
Max. participants 60
Study board
Study Board for HA/cand.merc. i erhvervsøkonomi og matematik, MSc
Course coordinator
  • Søren Bundgaard Brøgger - Department of Finance (FI)
Main academic disciplines
  • Finance
  • Economics
Last updated on 19-09-2017

Relevant links
Learning objectives
To achieve the grade 12, students should meet the following learning objectives with no or only minor mistakes or errors:
  • Understand the mechanics of derivatives markets
  • Understand market terminology regarding fixed income derivatives
  • Understand the concept of hedging and the relation to pricing
  • Understand the nature of the risk(s) associated with the different instruments covered in the course
  • Understand the nature and motivation of the different participants in the fixed income derivatives markets
  • Be able to use pricing models in Excel/VBA to compute prices and hedge ratios of plain vanilla derivatives
  • Be able to assess and quantify the risks associated with different instruments and construct an appropriate hedge
  • Be able to assess the appropriateness of different pricing models in a given situation
  • Be able to critically assess news media coverage of derivatives
  • Be able to apply models and concepts in a real-world setting, e.g. by devising and executing an interest rate hedge for a corporate bond issue
  • Be able to identify badly structured derivatives that could lead to disastrous outcomes for both counterparties
  • Be able to independently implement standard (closed-form) pricing models in Excel/VBA
Course prerequisites
The course is not intended to be an introductory course. Students are assumed to be familiar with basic fixed income concepts (such as yield curves, duration, convexity) and basic Black-Scholes theory (e.g. from “Corporate Finance and Incentives” or “Pricing Financial Assets”), at least at the level of the Hull textbook ("Options, futures, and other derivatives").

Furthermore, VBA programming will be an integral part of the course. While no prior knowledge of VBA is assumed, students are expected to have some basic programming experience and some familiarity with Excel is a definite plus.

In exchange for a reading list that is short in terms of the page count, the lectures will be dense and students are expected to devote considerable time over the course of the semester to implement pricing functions in VBA/Excel. To facilitate this, lectures will address not only the relevant theory but also include computer sessions that address practical issues.
Examination
Fixed Income Derivatives: Risk Management and Financial Institutions:
Exam ECTS 7,5
Examination form Oral exam
Individual or group exam Individual exam
Duration 20 min. per student, including examiners' discussion of grade, and informing plus explaining the grade
Preparation time With the listed preparation time: 20 Minutes
Grading scale 7-step scale
Examiner(s) Internal examiner and second internal examiner
Exam period Summer
Aids Open book: all written and electronic aids
The student is allowed to bring to the preparation room: Simple writing and drawing utensils, laptop/tablet as a reference book (NB: there are no electric outlets available), any calculator, books including translation dictionaries, compendiums, notes. PLEASE NOTE: Students are not allowed to communicate with others during the preparation time.
Make-up exam/re-exam
Same examination form as the ordinary exam
Course content and structure

Over the last decades there has been an explosive growth in the use of fixed income derivatives. Derivatives are now commonly used not only in financial institutions but also in many private and public entities. At the same time, the widespread use of derivatives is often blamed for playing a destabilizing role in the recent financial crisis.

 

The course will give a thorough understanding of fixed income derivatives, with a focus on how they are used and traded in practice. Fixed income markets, including interest rate swaps, swaptions, caps, floors and credit default swap indices, are some of the most actively traded financial markets, and underpin much of the banking system.

 

Using the quantitative tools employed in industry, students will learn how to characterize financial risks and how derivatives can be used to mitigate these. As such the course is relevant for students interested in pursuing careers in investment banking, in a public or private treasury operation or within the regulatory authorities.

 

 

The lectures will be quite quantitative in nature, as the main pricing models will be derived and explained in detail. Nonetheless, lectures will also focus on how derivatives are traded in practice and considerable time will be spent on covering various market standards to ensure that the models are practically applicable. The focus will be on products that are actually traded – how they work, how they are priced and how the risk is quantified and hedged – in a framework that is as close to reality as possible.

 

Next to the lectures, students will spend considerable time building pricing and risk management models using Excel and VBA. By the end of the course, students will have built a small pricing library that is as close to market standards as possible.

 

 

 
Teaching methods
Lectures supplemented with computer sessions.
Feedback during the teaching period
There will be a series of home assignments that the students will have the possibility to discuss in class.
Student workload
Lectures 42 hours
Preparation 116 hours
Exam 48 hours
Expected literature

Linderstrøm, M. D. (2010). “Fixed income derivatives.” Lecture Notes, University of Copenhagen

 

Lecture slides and additional lecture notes

 

Hagan, P. et al (2002). “Managing smile risk”. Wilmott Magazine (2002)

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Last updated on 19-09-2017