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The objective of the course is to present the students with the basic
paradigms of modern financial theory, to provide a foundation for
analyzing risks in financial markets and study the pricing of financial
Topics will include the calculation of risk and return, market
efficiency, choice under uncertainty and portfolio theory,
asset pricing (CAPM), bonds and term structure, futures and forward
contracts, option pricing, and applications of derivatives.
Additionally, the IT applications lab will be a fully-integrated
component of this class.
Concepts will be applied using a variety of computer software.
A new feature of the course will be risk management.
The course will discuss why firms should or not hedge financial risks,
and methods to control risks. This topic requires a good
comparative understanding of various financial instruments.
Risk management is becoming an essential function in financial
institutions, serving as a bridge between the front office (trading
desk) and back office (trade processing and record keeping).
The need for integrated risk management has been brought home
by spectacular failures such as those of Barings, Metallgesellschaft,
Orange County and Daiwa. Global risk management, however, presents a
formidable information technology challenge, since it requires
integration of computer systems, common databases and pricing
models across front, middle, and back offices.
This course and corresponding IT lab will be team-taught by Professors
Philippe Jorion and Eli Talmor.
Course material includes professor's notes and powerpoint presentations. The texts are:
Robert Haugen, Modern Investment Theory , 4rd Edition, Prentice Hall, 1996,
Philippe Jorion, Big Bets Gone Bad: Derivatives and Bankruptcy in Orange County, Academic Press, 1995
with in addition selected chapters from other texts and journal articles.
The same grade will be assigned to the class and associated IT Lab, which count for a 1.5 course. The grade will be based on:
I. Introduction to Financial Markets: Bonds, stocks, derivatives and other instruments
Review of statistics for finance
Reading: Haugen, Chapters 1, 2, 3
Jorion: Big Bets book
Jorion Notes: The Need for Risk Management
II. Portfolio Theory: Diversification, Mean-Variance analysis, factor models
Reading: Haugen, Chapters 4, 5
III. Asset Pricing Models: CAPM Theory, tests, APT, portfolio
Reading: Haugen, Chapters 6, 7, 9
IV. Market Efficiency: Theory and evidence
Reading: Haugen, Chapter 23, 24
V. The Term Structure of Interest Rates
Reading: Haugen, Chapter 12, 13
Jorion: Big Bets book, Chapter 8
VI. Bond Portfolio Management: The Treasury market, immunization
Reading: Haugen, Chapter 14, 15
Jorion Notes: Fixed Income Toolkit
VII. Derivatives: Futures, Forwards, and Swaps
Reading: Haugen, Chapter 19
Jorion: Big Bets book, Chapters 5, 6, 7
VIII. Derivatives: Option Contracts
Reading: Haugen, Chapters 16, 18
IX. Financial Engineering:
Other classes of contingent claims
Reading: Brealey and Myers, Chapter 22
Finnerty, "Financial Engineering in Corporate Finance: An Overview,"
Financial Management, Winter 1988.
X. Risk Management:
The hedging decision, Value-at-Risk
Reading: Institutional Investor, "Getting Risk's Number," February 1995.
Jorion Notes: Measuring Value at Risk
JP Morgan: "Introduction to RiskMetrics"
The Economist, "A Survey of International Banking," April 10, 1993
GSM - UC Irvine
© 1997 Philippe Jorion. ALL RIGHTS RESERVED.