2010-11 academic year

Financial Economics (21856)

Degree/study: degree in Business Sciences
Year: 2nd
Term: 3rd
Number of ECTS credits: 5 credits
Hours of studi dedication: 125 hours
Teaching language or languages: Catalan, English
Teaching Staff: Cristina Tomàs, Diego Walter Pereira

1. Presentation of the subject

The aim of this course is to give then student an introduction to the study of capital markets and corresponding asset pricing methods. The main asset pricing principles considered are: i) asset pricing by absence of arbitrage opportunities, and ii) market equilibrium asset pricing. 

The first principle is especially useful for pricing derivative instruments (e.g. an option contract) whenever we know (or assume) what the price of the underlying asset (e.g. a stock) is and how it evolves. 

In order to price the whole universe of financial assets, however, we need to investigate how investors make their investment decisions (individual optimality) and how the coordination of these investors on the financial markets leads to the formation of prices (equilibrium analysis).

2. Competences to be attained

  • Be familiar with financial system in general, and its key role in Economics, focusing on financial markets.
  • Understand the main financial instruments.
  • Implement lack of arbitrage opportunities techniques in order to price financial assets both under  certainty and uncertainty.
  • Understand market equilibrium techniques in order to price financial assets under uncertainty.
  • Understand Expected Utility theory methods in order to build optimal portfolios (optimal asset allocation).
  • Be familiar with mean-variance framework analysis, and its applications for financial risk measurement, risk diversification and the construction of efficient portfolios.

3. Contents

  • Financial Economics: Instruments and Markets, Financial Securities: Definitions Bonds/Stocks/Derivatives
  • Fixed-income securities and arbitrage: Definitions, bond valuation, Basic Bonds (BB) and Fundamental Asset Pricing Equation 
  • Term structure of interest rates: Interest rates, Term Structure of Interest Rates, The forward interest rates, Theories on the Term Structure of Interest Rates
  • Fundamental Asset Pricing Equation under Uncertainty
  • Derivatives valuation: Contract definitions, uses, forward prices and put-call parity, option valuation under binomial model and Black-Scholes model, risk-neutral probabilities.
  • Portfolio Selection and prices under Certainty: bonds
  • Portfolio Selection and prices under Uncertainty: CARA+ normal
  • The Mean-Variance (MV) Framework: Preferences, portfolio risk, Diversification, MV frontier
  • Capital Asset Pricing Model (CAPM): market portfolio, Capital Market Line (CML), Beta risk, Security Market Line (SML)

4. Assessment

1. The exam's and practice's grades weight 60% and 40% of the final grade, respectively.
2. 6 groups will be formed in each class. All groups must solve and hand in all assignments. In addition, each group must present during class one assignment (randomly assigned). Practice grade is: 40% presentation and 60% corrected assignments.
3. Students must attend the corresponding class for that assignment to be evaluated for them.
4. Practice grades are kept for september.

5. Bibliography and teaching resources

5.1. Basic bibliography

"Economía Financiera", José Marín y Gonzalo Rubio, Editor: Antoni Bosch, Barcelona 2001

5.2. Complementary bibliography

Brealey, R.A. y S.C. Myers. Principles of Corporate Finance 9th Edition. McGraw Hill. 

6. Methodology

Theory Lectures: where the theoretical concepts are presented

Seminars: Students should present the solutions to problems based on the concepts introduced in the theory lectures.

7. Planning of activities

Week

Lecture

Theory

Seminar

1

1

T1: Financial Economics: Instruments and Markets, Introduction and Basic Concepts; Financial Securities: Bonds; Stocks, Derivatives

 

2

T2: Arbitrage and Fixed Income Assets, Absence of Arbitrage: Basic Concepts and Examples, The Pricing of Fixed Income Assets Under Arbitrage

2

3

T3: The Term Structure of Interest Rates: Interest Rates and the Prices of Bonds; The Forward Interest Rates; Theories on the Term Structure of Interest Rates

 

4

T2-3: The Forward Interest Rates; Theories on the Term Structure of Interest Rates, Summary T1-2-3.

3

 

No Lectures

 

 

 

4

5

T4: The Fundamental Asset Pricing Equation Under Uncertainty: The Fundamental Ideas, Arrow-Debreu Securities and the Fundamental Asset Pricing Equation

 

6

T5: Derivative Valuation (I): Options and Futures: Basic Aspects

5

7

T5: Derivative Valuation (II): The Pricing of Options (I); The Pricing of Futures; put-call parity

 

8

T5: Derivative Valuation (III): The Pricing of Options (II); Risk Neutral Probabilities

6

9

T4-5: Summary T4-5

1. Instruments and Markets: Futures/Swaps, Markets in Spain, Order book, margin calls

 

 

7

10

T6: Portfolio Selection and Prices Under Certainty: Bonds

2. Duration and Term Structure of Interest Rates

11

T7: Portfolio Selection and Prices Under Uncertainty: CARA+normal

8

12

T8: THE MEAN-VARIANCE FRAMEWORK (I): Formal Justification of the Mean-Variance Framework, Risk and Return in Financial Markets

3 American Option valuation under Binomial method

 

 

9

13

T8: THE MEAN-VARIANCE FRAMEWORK (II): The Construction of Efficient Portfolios

4 VIX, "Greeks" y Black-Scholes Hedging

14

T9: The Capital Asset Pricing Model (CAPM) (I): The Market Portfolio and Beta Risk; cartera mercado, Graphical and Analytical Derivation of the Capital Market Line (CML)

10

15

Tema 9: The Capital Asset Pricing Model (CAPM) (II): Graphical and Analytical Derivation of the Security Market Line (SML); What is Beta?

5. Mean-Variance frontiers and portfolio performance

 

 

11

16

T6-9: Summary topics 6-7-8-9

6. CAPM & Fama-French