Class 1: Introduction
Introduction to the Financial System
Overviews of Equity, Fixed Income, Currencies and Derivatives
Questions for Next Class
Class 11: Equity Options Part 2:
The Black Scholes Model
Stock prices follow a geometric Brownian motion. Translating into discrete time, stock prices follow a Random Walk:
t + t+t
This model i
Classes 8 & 9: The Equity Market
Cross Sectional Variation in Stock Returns
Equities are common stocks, representing ownership shares of a corporation. Two
limited liability: non-nega
Classe 15: Forwards, Futures & Swaps
Interest Rate Derivatives
Interest rate swaps, caps, oors, and swaptions are over the counter
(OTC) interest rate derivatives.
Broadly dened, a derivative instrument is a formal agreement
Class 21: Hedge Funds
The Beginning of Hedge Funds
In 1949, Alfred Jones established the rst hedge fund in the U.S.
At its beginning, the dening characteristic of a hedge fund was that
it hedged against the likelihood of a d
Class 14: The Fixed Income Market
Part 2: Time Varying Interest Rates and Yield Curves
Figure 1: Time varying interest rates, Source: Bloomberg.
Class 10: Equity Options
Part 1: Pricing
SPX S&P 500 Index Options
Symbol: SPX Underlying: The Standard & Poors 500 Index is a capitalizationweighted index of 500 stocks from a broad range of industries. The component stocks
Class 22: Market Eciency
Types of Market Eciency
The Weak Form of Eciency: Prices accurately reect all in-formation that can be
derived by examining market trading data such as past prices, trading volume, short
Classes 6: The CAPM and APT
Part 1: Theory
So far, we took the expected return of risky asset as given. But where does expected
return come from?
Using the intuition that investors are risk averse, one explanati
Class 20: Active Portfolio Management
Financial instruments are increasing in
number and complexity
Securities, Random Walk on Wall Street
Reto R. Gallati
MIT Sloan School of Management
February 5th 2003
A brief review of probability distributions
Evaluating random events with normals.
Class 3: Portfolio Theory
Part 1: Setting up the Problem
A Little History
In March 1952, Harry Markowitz, a 25 year old graduate student from the University
of Chicago, published Portfolio Selection in the Journal of Finance
Class 4: Portfolio Theory
Part 2: Extensions
Should someone with longer investment horizon put more in the stock market?
Is there value in dynamic re-balancing?
How do market crashes aect investment behavior
Class 5: Portfolio Theory
Part 3: Optimal Risky Portfolio
Having determined the appropriate exposure to risk, the investors next task is to
build his risky portfolio rp .
This selection will be made from the
Class 18: The Credit Market
Part 2: Credit Derivatives
Credit derivatives are nancial instruments whose payos are linked to
certain credit events.
A commonly stipulated credit event is default by a named issuer,
Class 16: Risk Management
The recent, notable increase in focus on nancial risks can be traced
in part to the concerns of regulatory and investors about risk exposure
of nancial institutions through their large
Class 23: Commodities
The following table taken from the annual report of the Bank for In
ternational Settlements (BIS) reports the spectacular growth in exchange-traded derivatives, such as futures and options.
15.433 INVESTMENTS Class 7:
The CAPM and APT Part 2:
Applications and Tests
Predictions and Applications
CAPM: In market equilibrium, investors are only rewarded for
bearing the market risk.
APT: In the absence of arbitrage, in
Class 19: Security Analysis
What explains the price we observe from the market?
In an ecient market, the price reects all information available to pub
lic. Implicitly, there should be a pricing model that links