Financial Management

Undergraduate Students of Applied Mathematics


Course Description

Financial engineering involves the design, development, and implementation of innovative financial instruments and processes, and the formulation of creative solutions to problems in finance.

During the last decade, we have witnessed an increased use of operations research techniques for many diverse aspects of financial engineering.

Operations research tools such as decision analysis, statistical estimation, artificial intelligence (neural nets, fuzzy logic, genetic algorithms), simulation, optimization, stochastic processes and decision support systems are becoming more indispensable in several domains of financial operations.

Many factors have contributed to the growth of financial engineering including (i) technological advances, changing regulations; (ii) globalization of financial markets, increased competition, (iii) ability to solve complex financial models, price volatility.

Financial engineers are involved in many important areas of an organization:

In corporate finance, they develop new instruments or add new feautures to an existing instrument in order to secure the funds necessary for the operation of large-scale businesses.

In securities, they develop innovative trading strategies.

In investments and money management, they develop new investment vehicles such as money market funds, the repo market and mutual funds

In risk management, they identify and measure the risk of different securities and consstruct and maintain portfolios with th specified risk-return characteristics

Goals

The main goals of this course are

to introduce and explain a range of financial securities and the markets in which they trade,

to provide a conceptual framework of the firm's investment and financing decisions,

to examine of the management of equity and fixed income investments,

to analyse individual securities, the formation of these securities into portfolios,

to use derivative securities to modify the return/risk profiles of more traditional stock and bond portfolios.

Prerequisites

Basic knowledge in analysis and probablity theory.

Student Obligations

Students will be required to present a case study before the exam.

Course Resource

Robert Fullér, An Introduction to Financial Management,
TEMPUS project No. S_JEP-11097-96,
Eötvös University Press, Budapest, 1997, 136 pages.

Course Overview

1. Markets and Instruments

The Money Market, Equity Markets, The Fixed-Income Capital Market
Bonds, Zero-coupon bonds, Bond Ratings, Derivative Markets

2. The International Financial Markets

Purchasing Power Parity, Interest Rate Parity
Open Fisher Theory, The Expectations Theory of Exchange Rates
Efficient Markets Theory, Financial Instruments, Equity financing
Debt financing - (Bonds, Debentures, Warrants, Convertible bonds, Eurobonds)

3. Basic Concepts

Real and Nominal Rates of Interest, Continuous Compounding
Present Value of Money, Risk and Risk Premiums, Market Price Ratios

4. Portfolio Theory - An Introduction

Risk Attitudes, Portfolios of Two Risky Assets
Portfolios of one Risky and one Risk-free Assets,

5. Optimal Risky Portfolios

6. The Capital Asset Pricing Model

Why do all Investors Hold the Market Portfolio? The Risk Premium on the Market Portfolio
The Expected Return-Beta Relationship, The Security Market Line
Arbitrage opportunities

7. Fixed-income securities

Treasury Bonds and Notes, Bond Pricing, Bond Yields
Yield to call, YTM versus HPR, Zeros

8. Options Markets

The option contract, Rights issues and stock splits

9. Option Strategies

Protective Put, Covered Call, Straddle, Spreads, Collars
Short Selling, The Put-Call Parity Theorem

10. Option Pricing

Determinant of Option Values, Restrictions on Option Prices
Early Exercise and Dividens, Early Exercise of American Puts
Binomial Option Pricing, Two-state Option Pricing, The Binomial Model

11. Black-Scholes Option Valuation

Put option valuation
Hedge Ratios and the Black-Scholes Formula

12. Futures Markets

Futures Contracts, Hedging and Speculation
Optimal Hedge Ratio, Forward Contracts
Forward and futures contracts on currencies

13. Swaps

The Theory of Comparative Advantage, Interest Rate Swaps
Foreign Exchange Swaps, Commodity Swaps

14. The Budapest Stock Exchange: Some Quotations

OTP Bank Ltd., Consolidated Balance Sheet
Consolidated results, Shareholders' equity, Plans for 1997
MOL, Q1-Q3 1996 Results

Recommended literature

Z.Bodie, A.Kane and A.J.Marcus, Investments (Third Edition), Irwin, Times Mirror Higher Education Group, Boston, 1996.

R.A.Brealey and S.C.Myers, Principles of Corporate Finance, (Fourth Edition), McGraw-Hill,1991.

J.C.Hull, Options, Futures and Other Derivative Securities, (Second Edition), Prentice-Hall, 1993.

J.F.Marshall and K.R.Kapner, The Swaps Markets, (Second Edition), Kolb Publishing Corporation, 1993.

R.Pike and B.Neale, Corporate Finance and Investment, Prentice-Hall 1993.