Insegnamento a.a. 2011-2012

Course Objectives

The course aims at providing the basic tools to examine economic activity in financial markets: how securities are priced and how are used. The course covers the essentials, while leaving more specialized topics to follow-up optional modules. Students gain a general knowledge of the valuation and use of bonds, stocks and derivatives within typical portfolio optimization problems.

Course Content Summary

• Deterministic cash flows. The basic premise in cash flow modeling is the understanding of the time value of money. Thus, the timing of cash flows affects asset values and rates of return. The simplest cash flows are those that are deterministic, either with one or several periods. Fixed-income securities belong to this class and can be analysed by means of interest rates.
• Random cash flows. Typically, the initial cost of an investment is known, while its future cash flows are random. Cash flow uncertainty can be analysed by means of different techniques and we focus here on the mean-variance and the arbitrage analysis. The starting point of our analysis is that investors like returns and dislike risk. After defining precisely what the term risk means we relate it to investments and look at methods to measure risk. Finally we discuss the relation between risk and return, and use it to determine security prices.
• Derivative cash flows. The next level of complexity pertains to cash flow streams that are random and depend functionally on another asset. We introduce simple derivative securities such as futures, forwards and (European) options and describe how they work. Pricing is done through arbitrage analysis and we see how derivative assets can be used to increase returns or limit losses.

Detailed Description of Assessment Methods

Textbooks

• D.G. LUENBERGER, Investment Science, Oxford University Press, 1998.

Prerequisites

Students are expected to have intermediate quantitative skills (calculus, algebra, and statistics), and basic knowledge of Excel. Prior exposure to finance is beneficial, although not essential.