1.1
1. FORWARD CONTRACTS
Reading: Luenberger Chapter 10
Prerequisite: Interest rates. Read (review)
Luenberger Chapter 4.
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1.1 Forward Contracts
A Forward Contract is an agreement between two parties
to buy/sell an asset at an agreed upon price at
3.1
3. Optimal Hedge Ratios
Using Hull (2011) notation rather than Luenberger (1998)
S
F
S
F
change in spot price over life of hedge
change in futures price over life of hedge
standard deviation of S
standard deviation of F
correlation between S and F
Hed
4. Op&ons
Reading: Chapter 12, Chapter 11 of
Luenberger
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4.1 Options types
A call is an option to buy
A put is an option to sell
A European option can be exercised only
at the end of its life
An American option can be exercised at
any tim
6. PORTFOLIO THEORY
Reading: Luenberger Chapter 6
Consider a portfolio of n assets (e.g. stocks). A
portfolio is constructed by weighting asset i by weight
wi .Stock picking is accomplished by increasing the
weight of the stock that you like, and setting
7. Capital Asset Pricing MODEL
Reading: Luenberger Chapter 7
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Sharpe (1964), Lintner (1965)
Nobel Prize: Sharpe (1990)
Based on Mean Variance Portfolio Optimization
Rules for how to invest (normative economics)
Main Result Under Equilibrium
9. UTILITY FUNCTIONS
Reading: Luenberger, Chapter 9
(Many of the slides in this lecture are modifications
from last years course by Professor Martin)
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9.1 EXPECTED UTILITY FRAMEWORK
WO
W
U(w)
E[U(W)]
Initial Wealth (fixed)
End of Period Wealth (
5. Binomial Tree Model
Reading: Chapter 12, Chapter 11 of
Luenberger
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5.1 A Toy Model That Could Later Be Made
Very Realistic
Suppose a stock is currently at price S.
In a later time t, it could move up and down,
but only to one of the two known states
Derivation of Ordinary Linear Square
Estimators
A factor model for y i ( the subscript could denote time;
then it is a time series) :
y i = + xi + i
x i are the regressors (factors),
and and are the regression coefficients that need to be estimated.
are