FNCE30007: Derivative Securities

25% Mid-Semester Test, 75% Final Exam

Derivative Securities is definitely the most conceptual and theoretical subject in the Finance major. It (obviously) relies on the mechanics of options and forwards which you may have experienced in your prior subject studies but not to this degree. I think Business Finance taught the payoff of an option at maturity? Yeah that's definitely assumed knowledge (it’s revised a tiny bit), but this subject takes that so much further. Looking back, I actually found it pretty fun. Derivatives interest me in a number of ways but particularly because while we model the probability and payoffs and stuff, it's sort of interesting to think about the micro component. For a derivative on a stock, that stock still represents part of a company. So we're like two levels higher than the company being the equity component (stock) and then being the derivative on the stock. Anyway that may have been gibberish but I think DS is a fun subject lol.

I think the main reason why DS is coined the hardest subject is because, like I said, it relies a lot on theory and conceptual type understanding. For our semester (and this changes each semester) we begun with options and basic characteristics of options (payoffs at maturity, bounds, arbitrage opportunities on those bounds and some option trading strategies like straddles and strangles) then onto pricing models. Firstly the binomial model is taught which is pretty generally easy and I think most people understand how it works. This model is quite diagram based (i.e. drawing binomial payoff trees) and can be examined in a lot of different ways (currencies, options on forwards, dollar dividends, proportional dividends) so it’s pretty crucial you know it inside out. The second model is the black Scholes model - perhaps the most revered model in finance. This model is more conceptual and less diagrammatic but for our semester there was not much in particular to know (just some certain variations of the typical formulas). After which, we were introduced to forwards and futures, then currencies and hedging. Options are obviously the main component of DS (again, this changes every semester) taking up 6 or 7 weeks in total, but your understanding of options does extend to help with other topics in the class. You also cover some minor theory points like implied volatilities, hedging errors, risk neutral valuation and a tiny bit about the Greeks. Last semester I believe they covered the Greeks in detail instead of currencies – so again, beware it changes. The semester concludes with a lecture on the GFC and how credit derivatives work (which is not examinable, but so many people were keen on it).

So, for the lectures. Neal Galpin took our first 3 or 4 lectures and he was boss. He spoke in that he hated using theory to prove things and preferred diagrams etc - I think that definitely helped my understanding and a lot of my peers understanding. John Handley took the remainder of the course and I thought there couldn't be someone as good as Neal but damn he was boss too. Both of them speak perfectly, at a leisurely pace, with interesting tidbits of information sprinkled in here and there. You could honestly tell they were passionate about what they do and that's awesome. The lectures weren't necessarily jam packed of information but I think it was assumed you revise everything. Generally it is easy to work through the lectures as they are presented - sometimes there's questions in there that can help solidify your understanding. I finished the subject only a couple of days ago, but thinking back about lectures, they were so bland (no formatting, black and white pdf) but it goes to show you that it legit is the lecturer that keeps your attention. I do believe it was important to show up to lectures rather than watching them online, because sometimes John would jot down how the theory works or a little diagram to help understanding (these were boss too).

There were no tutorial marks, so it really was upon yourself to show up and attempt the questions. The questions were legit so much harder than the exam, but it was good to understand how for example put-call parity can be expanded in situations with forwards, or in situations with dividends. Some questions involved algebra and like year 10-12 maths to solve it lol, this irked me to no end because I haven't had to know logarithm transposition rules since high school. I think, if not just for DS, it was actually kind of interesting to remember all this maths stuff that I had forgotten over the course of my degree - these types of questions were never explicitly said to be un-examinable but they weren't examined in our semester. Other things in tutorials just revolve around some easy concepts (matter of fact these questions popped up in the exam....). I had Yudong as my tutor, and he was awesome. He is also the online tutor and definitely knows everything in the course and more. If you ask him a question, he’ll explain it in a couple different ways to help your understanding and even show you how things like this can be applied in practice which was cool. I believe a lot of tutors in the subject were really good though, and I definitely recommend using OLT if you're struggling. It's easy to get side tracked in derivatives when you think what else there could be (e.g. how could we extend binomial approach to american options with dividends) but I would say if it's not in the lecture then its probably not going to be examined.

As for assessment, we had a really easy semester. Firstly the mid semester test was 25% of the grade and for that reason, we were only tested on the first 3 weeks (25% of the course). There was a lot of content in these weeks and especially if you read the book because in the assigned readings there were a lot more trading strategies that weren’t mentioned in the lecture and it was never clarified whether these were examinable or not. However the test itself comprised of 12 questions, most of them being relatively easy. I think the average was about 73% or so, which seems low considering the difficulty. It’s very easy to stuff up on questions if you don’t read it carefully – for example payoff versus profit, or short versus long. There was maybe one or two tricks to do with dividend timing, but that’s it. John said quite early on that he doesn’t like exams and would rather just teach people – I think that was reflected in the difficulty of the assessment.

Now, for the exam, it tested Lecture 4 to Lecture 10 (i.e. content after the mid sem up to the second last lecture) which wasn’t too much content. It made studying pretty easy. I highly suggest re doing tutorial work because some tutorial questions showed up word for word on the exam. We weren’t given a practice exam too. I don’t know my feelings about the exam – it was 6 short answer questions each work 10 marks to be done in 3 hours. People were leaving after 1 hour; it was that short. The first 5 questions were more or less the same as tutorial questions and the final question was a conceptual approach to using risk neutral valuation on the GBM process. I think this question was the one that was supposed to separate students but it seemed frustrating for me. Firstly because sooo much of the course went untested and all studying went unrewarded. Secondly because we hadn’t seen anything like this in the semester. I’m just hoping I got some marks for it lol, I know I didn’t get it right.

I suppose my overall review of this subject is really high. The 4.5 rating is only because I would’ve liked to see my studying go rewarded – but can I really complain?

Yes

Neal Galpin for the first three weeks, John Handley for the remainder of the course.

No

4.5 out of 5

Fundamentals of Futures and Options Markets (or whatever it's called) by Hull. You can use the previous 3 versions as readings were prescribed for all of them.

1x2 Hour Lecture, 1x1 Hour Tutorial

2017 Semester 2

TBA

25% Mid sem exam, 75% 3hr+15mins Final Exam

Remember options and futures and forwards from Bus Fi? Those are the focus of this subject. Also toss in a few things like portfolio insurance, dividend yields, etc which are quite similar conceptually to valuing options/forwards.

I’ve heard Ali, who only takes Sem 1, is the better lecturer for the year. His lectures are very overall concept focused and set out clearly. He has quite a few examples chucked in, but its sometimes hard to understand where the numbers come from during the lecture, so utilise the lecture recording afterwards and make sure you know what’s happening.

Seeing how easy the mid sem was, I think everyone was expecting a super hard exam… and that’s exactly what we got. There was a super long question on portfolio insurance (which is different to the one in the practice), and also two hard theory questions, swaps, margin account, arbitrage table, etc.

To prepare for the exam, do the provided textbook questions, and the practice exam questions. Don’t be surprised when you don’t know how to do them – there are lots of questions you haven’t seen before. It sort of makes you realise how much you don’t know, so going to a consult, and abusing the online tutor is a good idea. Its also good to go through the lecture examples as they sometimes don’t appear in tute work, but are examinable.

Yes, with screen capture.

Ali Akyol

Average was 17/20. Nuff said? Know the basics. To revise, do the practice questions provided (Ali literally gives you the textbook provided questions+answers), and the previous tute qs which aren’t from the book.

DS is often termed the hardest subject of the finance major, and you don’t really realise this until revision time. I guess the thing is to just keep up with the work and make sure you understand the basics, because otherwise you’ll have a lot to learn during revision time.

No, but two sets of practice questions.

3 Out of 5

Fundamentals of Futures and Options Markets (PNIE) 8th ed, Hull. I didn’t buy it, don’t know how useful it is. Survived without looking at it once though.

I do think having a good tutor is important for this subject. I had Allen, who is really good for explaining concepts, but I think other tutors may be better if you want solid, write-downable answers for your tute work. It depends on how you learn.

The pretute work is all uploaded at the start of semester, so I suggest printing it out as a book and pulling it out to attempt the pre-tute work. The tutors have all been told to teach us specific ways of answering some questions (profit tables, payoff diagrams etc) that aren’t reflected in the LMS uploaded answers, so its best to go to tutes.

1x2hr Lecture, 1x1hr Tute

2015 Sem 1