IILM Graduate School of Management

Academic Year: 2019-20

Module Name: 633. Financial Derivatives

(Nearest Indian Course Name): Futures, Options and Swaps

Brief Module Description:

The objective of this course is to introduce participants to derivative securities with particular focus on the
structure of these contracts, their use in risk management, and techniques used for their valuation.

Page 1 of 9
1. Introduction to the Module and Module Objective:

This course primarily discusses the pricing/valuation and use of financial derivatives, including forwards,
futures, options and swaps in risk management. We discuss the context in which these instruments
emerged (collapse of Bretton Woods, rise of monetarism and the formation of OPEC), the current stage of
development in the Indian scene (nature of instruments available, and trading nuances), and the expected
direction of its development in future.

Objective: This course aims to introduce participants to derivative securities with particular focus on the
(pay off), pricing of these instruments (and their dynamics), their use in risk management (as standalone
plain vanilla hedges to more complicated structures), and techniques used for their valuation. We will
learn the use of these instruments to hedge alternative risks in the context of a single asset as well as a
portfolio of assets.

You will need to carry your laptops to the class every day in working condition. The course delivery will
be MS Excel based.

Module Learning Outcomes:

1. Derivative basics and their application for long and short hedge
2. Pricing of options and futures
3. Combination and spread strategies using Options
4. Use options and futures contracts for portfolio risk management.
5. Valuation of swaps

2. Introduction to the Faculty

2.1 Area Chair Name: Raju Majumdar

Phone Number: 0120 6670675
Email id: raju.majumdar@iilmgsm.ac.in
Cabin Location: Second floor
Website URL: http://www.iilmgsm.ac.in/faculty/

2.2 Module Leader Name: Raju Majumdar

Phone Number: 0120 6670675
Email id: raju.majumdar@iilmgsm.ac.in
Cabin Location: Second floor
Website URL: http://www.iilmgsm.ac.in/faculty/

2.3 Tutors: Raju Majumdar

Phone Number: 0120 6670675
Email id: raju.majumdar@iilmgsm.ac.in
Cabin Location: Second floor
Website URL: http://www.iilmgsm.ac.in/faculty/

3. Module Pre-requisite: A basic understanding of calculus (graduation level) and probability theory
(covered in Year I of the program) is required for this course. Students are expected to come prepared
with the required readings before each class. The methodology followed in the class will combine
lectures, applications and case discussions. Lectures will address the assigned reading materials. The
required readings, lecture notes, and the assigned home assignments and cases are intended to support the
objectives laid down.

Page 2 of 9
4. Module Overview

Session Topic to be covered

1-2 An introduction to derivative contracts, their types and reasons behind their
emergence.

3-4 Pricing of Forwards & Futures, Using Forwards and Futures contract in Risk
Management

5-6 Basis Risk and Cross Hedging, Modifying Portfolio Betas using futures contracts

7-8 Getting familiarized with option payoffs, terminologies and trading

9-10 Put-Call Parity, Introduction to synthetic portfolios, Option Strategies (combination

and spread), A first look at Option Pricing

11-12 Pricing of Option contracts: Binomial and Black Scholes, Option Greeks and their
use in risk management

13-14 Using Options for managing risk: equity risk management and equity portfolio risk
management; Options on equity and index options

15-16 Workshop: Option Strategies

17-18 An Introduction to Swap Contracts: Currency and interest rate swaps

19 -20 Pricing of Swap Contracts

5. Module Readings

5.1 Main Readings: Options Futures and Other Derivatives, John C Hull, 8e, Pearson Education

5.2 References:

 Derivatives and Risk Management, J R Verma, Tata McGraw Hill, 2008

 Derivatives and Risk Management Basics, Chance and Brooks, Indian Edition, Cengage Learning
2008
 Derivatives: Valuation and Risk Management, Dubofsky and Miller, OUP, 2003
 Reilly & Brown, Investment Analysis and Portfolio Management, Cengage Learning, 8e, 2009

5.3 Newspapers & Journals: Please read the Economic Times or any financial newspaper on a regular
basis, The Wall Street Journal is another important source of information.

5.4 Recommended Articles, Other Material:

Option price calculator:
http://www.option-price.com/
https://www.bseindia.com/markets/Derivatives/DeriReports/OptionCalculator.aspx

Page 3 of 9
 Option trading strategies
https://www.nseindia.com/content/ncfm/sm_otsm.pdf
https://www.asx.com.au/documents/resources/UnderstandingStrategies.pdf
Credit Derivatives
https://www.bloomberg.com/news/articles/2018-06-05/how-a-twist-on-credit-derivatives-
warps-the-market-quicktake

5.5 Websites
 https://www.motilaloswal.com/markets/derivative-market.aspx
 https://www.isda.org/
 https://www.risk.net/derivatives
 https://economictimes.indiatimes.com/topic/derivatives-market

6. Session Plan

Session 1 and 2: Title: An introduction to derivative contracts, their types and reasons behind their
emergence. Getting familiarized with option terminologies and trading

Description of the session: Here we discuss the collapse of the Bretton Woods Agreement, the rise of
monetarism in USA and formation of OPEC as harbingers of the development of derivative contracts the
world over. We also get familiarized to option terminologies and the trading process for option contracts.

Learning Outcome: the context of emergence of derivative contracts, and how to trade in options

Required readings:
 Derivative Market in India, http://www.igidr.ac.in/~susant/DERBOOK/PAPERS/pm.pdf
 Indian Derivative Market
http://www.ny.frb.org/research/economists/sarkar/derivatives_in_india.pdf
 Chapter 1, Page 1-19, Options Futures and Other Derivatives, John C Hull, 7e, Pearson
Education, 2009
Desired Reading
 Chapter 21, Page 847-890 Reilly & Brown, Investment Analysis and Portfolio Management,
Cengage Learning, 8e, 2009

Session 3 to 4: Title: Pricing of Forwards & Futures, Using Forwards and Futures contract in Risk
Management

Description of the session: These three sessions will introduce you to the pricing of forward and futures
contracts on investment assets and on consumption assets and discuss the no-arbitrage pricing relations.
We also discuss normal backwardation and contango. Then we move on to understand the use of futures
contract in risk management, here we analyze several pay-off conditions to understand how futures may
be used to mitigate risk.

Learning outcome: Equilibrium/no arbitrage pricing conditions for Forward/futures contract and their
use in protecting the downside.

Required reading: Chapter 5, Page 99-127, Options Futures and Other Derivatives, John C Hull, 7e,
Pearson Education, 2009

Page 4 of 9
Session 5 and 6: Title: Basis Risk and Cross Hedging, Modifying Portfolio Betas using futures contracts

Description of the session: Basis risk is the financial risk that offsetting investments in a hedging
strategy will not experience price changes in entirely opposite directions from each other. This imperfect
correlation between the two investments creates the potential for excess gains or losses in a hedging
strategy, thus adding risk to the position. We discuss Basis Risk in this section followed by looking at
using futures contract in risk management of portfolios.

Learning outcome: Basis risk: its cause and effect; hedging equity and equity portfolios.

Required reading:
 Definition of basis-risk http://economictimes.indiatimes.com/definition/basis-risk
 Chapter 3, Page 45-71, Options Futures and Other Derivatives, John C Hull, 7e, Pearson
Education, 2009
An article and excel sheet on the same will be shared with students.

Session 7 and 8: Getting familiarized with option payoffs, terminologies and trading

Description of the session: Here we discuss option contracts in detail. We discuss the types of option in
the context of the rights they confer on the buyer with regard to transaction type and transaction time, the
concept of exercise or strike price, their pay off structures, terminologies and trading.

Learning outcome: Understanding options, the payoff structure and an introductory look into factors
influencing option prices.

Required reading: Chapter 8, pp 179-218, Options Futures and Other Derivatives, John C Hull, 7e,
Pearson Education, 2009
Session 9-10: Put-Call Parity, Introduction to synthetic portfolios, Option Strategies (combination and
spread), a first look at Option Pricing

Description of the session: Put/call parity is a captivating, noticeable reality arising from the options
markets. By gaining an understanding of put/call parity, one can begin to better understand some
mechanics that professional traders may use to value options, how supply and demand impacts option
prices and how all option values (at all the available strikes and expirations) on the same underlying
security are related.

Learning Outcome: here we discuss a fundamental equilibrium relationship in between a call and a put
option, get an idea of the upper and lower bounds of option prices and learn how to combine options
given a specific market outlook.

Required Readings:
 Chapter 8, Page 179-198, Options Futures and Other Derivatives, John C Hull, 7e, Pearson
Education, 2009
 http://www.sebi.gov.in/faq/derivativesfaq.html (a glossary of terms used in the derivatives
market)

Session 11-12: Pricing of Option contracts: Binomial and Black Scholes, Option Greeks and their use in
risk management

Description of the session: Here we discuss the two available frameworks for option pricing, one in
discrete time (Binomial Model) and the other in continuous time (Black and Scholes Model). We discuss

Page 5 of 9
the option Greeks, namely delta, gamma, theta, rho and Vega and their interpretation and use.

Learning Outcome: The pricing of options and corporate liabilities

Desired Readings:
 Chapter 13 (Page 277-307), and 17 (Page 357-388), Options Futures and Other Derivatives, John
C Hull, 7e, Pearson Education, 2009
 Option Pricing: A Simplified Approach, John C. Cox, Stephen A. Ross, Mark Rubinstein,
http://www.isb.uzh.ch/studium/courses06-07/pdf/crrarticle.pdf

Session 13-14: Using Options for managing risk: equity risk management and equity portfolio risk
management; CAPM and index options

Description of the session: How do we use option contracts in managing risk of a single security and that
of a portfolio? How the cost of insuring downside risk of a portfolio does vary with the risk in the
portfolio? Can a hedger combine options and portfolios in order to adjust market risk of the portfolio? We
deal with these issues in this class.

Learning Outcome: Equity and equity portfolio hedging using option contracts/portfolio insurance

There are no study materials for this session. Based on what all we have learnt in options we will apply
the same to hedge equity and equity portfolio risk

Session 15-16: Workshop: Option Strategies

Description of the session: Option strategies are tools for creating desired payoffs by combining options
of different types (calls and puts) and strike.

Learning Outcome: Here we learn the possible combination and spread strategies that an option trader
may take recourse to in order to create a certain payoff structure that is best suited for an expected market
outcome.
Required Reading: Please refer to the following URL’s to prepare for these two sessions:
http://www.asx.com.au/documents/resources/UnderstandingStrategies.pdf
http://www.theoptionsguide.com/
https://www.optionsplaybook.com/option-strategies/
http://www.optionstrading.org/strategies/a-z-list/

Session 17-18: An Introduction to Swap Contracts: Currency and interest rate swaps

Description of the session: Here we will discuss in detail how swaps help us in mitigating risk arising
out of exchange rate and/or interest rate fluctuation.

Learning Outcome: The rationale behind the existence of swap contracts as a over-the-counter product
for risk management.

Required Reading: Chapter 11, pp 305-322, Derivatives: Valuation and Risk Management, Dubofsky
and Miller, Oxford University Press, 8e.

Session 19-20: Pricing of Swap Contracts and their use in risk management

Description of the session: In these two sessions we will put to use all our learning with regard to the

Page 6 of 9
government debt market the zero coupon yield curve and the forward rate curve in pricing of floating rate
instruments in general and swaps in particular.

Learning Outcome: Principles of valuing fixed-fixed and fixed –floating currency and interest rate swap

Required Reading: Chapter 12-13, pp 325-343, Derivatives: Valuation and Risk Management, Dubofsky
and Miller, Oxford University Press, 8e.

You may refer to the following links for more details:

 The Pricing and Valuation of Swaps http://www2.gsu.edu/~fncgdg/material/Swaps.pdf

 Class Note on Valuing Swaps
http://finance.wharton.upenn.edu/~bodnarg/courses/CF/swapsnote.pdf
 Swaps in Finance | Definition | Examples |Valuation https://www.wallstreetmojo.com/swaps-
finance/

7. Assessment Plan

Date of Nature of Assignment

submission Assignment
Session 14 Individual Identifying and hedging currency risk in a company of your
choice (5 marks)
Session 9 and Individual 2 Quizzes (5 marks * 2=10 marks)
Session 17
On Individual End term examination (15 marks)
Completion

Details of Assessments:
7.1 Component 1: Individual Assignment –5 marks: You are required to choose a company with
sufficient foreign currency exposure in their balance sheet. Any company having more than
10% of its revenues/costs in foreign currency is eligible for selection. For this company you
will be required to find out the alternative exposure management strategies and submit a
written assignment on the same.
7.2 Quizzes: there will be two quizzes of 5 marks each. Questions asked in the quiz will test (a)
your capacity to interpret market data, and application skills.
7.3 End term examination: this assessment will be closed book and will have three questions of 5
marks each. The aim will be to
 Measure the extent to which you are able to synthesize learning/theory into problem
solving.
 Measure your ability to selectively analyse information and derive conclusions.

8. Maps
8.1 Assessment Map
Module Name: A1 A2 A3 A4 A5

Financial Derivatives  

A1- Individual assignment/quiz A2- Group assignment

A3- Open book examinations A4- Closed book examinations A5- Presentations

Page 7 of 9
 8.2 Teaching Map
Module Name: T1 T2 T3 T4 T5 T6

Financial Derivatives  

T1: Lectures T2: Seminars/Tutorials T3: Projects

T4: Case Discussion T5: Guest Lectures/Industrial Visit T6: Lab Sessions

8.3 Curriculum Map

Programme Learning Outcomes

Module Name: Finance I L1 L2 L3 L4 L5 L6 L7

Taught  

Assessed  

 L1 - An understanding of organizations and management techniques to allow investigation into

business and management issues.
 L2 - An ability to acquire, analyze and understand data and information for managerial decisions.
 L3 - Critical thinking and informed judgment leading to problem solving, decision-making and
negotiating skills
 L4 - Cognitive flexibility which enables adaptability to uncertainty in a rapidly changing business
environment
 L5 - An understanding of disruptive and technological change and the ability to seek innovative
and entrepreneurial solutions.
 L6 - Emotional intelligence and people’s skills in communicating, working in teams and with
people.
 L7 - Being cognizant of the impact of individual and corporate actions on society, recognizing
responsible and inclusive business practices and sensitivity to the social, economic and
environmental responsibilities of business.

Page 8 of 9
9. Module Readings Grid
Sl. Title Topic Discussed No of pages Shared/
No Isolated
Brief Cases
Cases
Essential Readings: Text Book Options Futures and Other Derivatives, John C Hull, 7e, Pearson
Education, 2009
1 Chapter 1, Options Futures and Introduction to Derivative Pp 1-19 (20)
Other Derivatives, John C Hull, 7e, Contracts
Pearson Education, 2009
2 Chapter 5, -do- Determination of forward and Pp 99-127 (29)
futures prices
3 Chapter 3, -do- Hedging strategies using futures Pp 45-71 (17)
4 Chapter 8, -do- Mechanics of options markets Pp 179-198 (20)
5 Chapter 9, -do- Properties of stock options Pp 199-218 (19)
6 Chapter 13 and 17, -do- The Black–Scholes–Merton Pp 277-307(31)
model, The Greek letters Pp 357-388(32)
7 Chapter 11, Derivatives: Valuation Swap Contracts Pp 305-322 (18)
and Risk Management, Dubofsky
and Miller, Oxford University
Press, 8e.
8 Chapter 12-13, -do- Valuation of Swap Contracts Pp 325-443
(Interest rate and currency swaps) (119)
9 Option strategies (NSE and ASX Option Strategies Pp 50 Shared
material)
Desired Reading
1 Chapter 21, Investment Analysis Introduction to Derivative Pp 847-890 (54)
and Portfolio Management, Reilly Contracts
& Brown, Cengage Learning, 8e,
2009
2 Option Pricing: A Simplified Option Pricing Pp 25 Shared
Approach, John C. Cox, Stephen A.
Ross, Mark Rubinstein,
Videos
1. Foreards and Futures Contracts, Contango and Backwardation Isolated
https://www.khanacademy.org/economics-finance-domain/core-finance/derivative-
securities/forward-futures-contracts/v/forward-contract-introduction
2. Option contracts, calls and puts, Put-Call Parity Isolated
https://www.khanacademy.org/economics-finance-domain/core-finance/derivative-
securities/put-call-options/v/american-call-options
3. Black-Scholes and Implied Volatility Isolated
https://www.khanacademy.org/economics-finance-domain/core-finance/derivative-
securities/black-scholes/v/introduction-to-the-black-scholes-formula
4. Black-Scholes Explained Isolated
https://www.youtube.com/watch?v=Xy_txjKPNyg
5. Interest Rate Swaps Isolated
https://www.khanacademy.org/economics-finance-domain/core-finance/derivative-
securities/interest-rate-swaps-tut/v/interest-rate-swap-1

Page 9 of 9