Financial institutions, international finance and risk management

MARIA AUGUSTA MICELI

The course intends to rationalize the context in which financial decisions and assessments are formed to provide students with the ability to reason and modify rules. The course aims to teach students the construction of pricing models for goods, contracts, financial assets and risk, creating a bridge between the microeconomic decisions theory, financial pricing, and operational matters. To this aim, it will be necessary to strengthen some micro-economic instruments as well as the bases of the theory of prices and contracts in asymmetric information conditions.
The aim is to teach students the ability to evaluate financial activities and/or services, distinguishing the context according to the quality of the supply and demand of the market in which one operates, possibly creating new methods of evaluation. "Quality" is a term used to summarize the degree of information of the participants, the structure of the market and the degree of competition, the objectives of the financial institution, the liquidity and obviously the risk tolerance of the various operators, the expectations.

Following the Dublin criteria, the student will have to demonstrate:
A) (knowledge and understanding) to have understood and be able to apply financial quantitative tools used in industry to price financial assets;
B) (applying knowledge and understanding) to know the context and the assumptions necessary to use each evaluation tool, and their weaknesses. Be therefore able to propose different evaluation methods in different contexts;
C) (making judgements) judgment autonomy in choosing assessment methods, including a subjective analysis of the consequences;
D) (communication skills) to be able to explain the quantitative material and its assessments to specialists and also to non-experts (customers),
E) (learning skills) independent learning ability to undertake subsequent studies.

Considering the time constraints, topics will be dealt with in a synthetic way. Since the aim is to make the student able to translate the different problems in quantitative terms and to learn how to solve them and translate a decision in a "numerical price" according to the given context.

Following the Dublin criteria, the student must demonstrate:
A) the ability to use the quantitative tools used in the financial industry, to price financial assets,
B) know the context and the assumptions needed to use each evaluation tool and their weaknesses in different contexts and assumptions and therefore be able to propose different evaluation methods,
C) autonomy of judgment in choosing the evaluation methods, including a subjective analysis of the consequences,
D) being able to explain the quantitative material and their evaluations to specialists and also to non-experts (clients),
E) independent learning ability to undertake further studies.

Microeconomics.
Math 1

Consumer Theory Review: Income and Substitution Effects
Consumer Theory: Choices and the Slutsky Equation
Consumer Theory: Intertemporal Choice and Definition of Savings and Endowment Income
Intertemporal Choice: Multiple Periods and Intertemporal Preference Rate vs. Interest Rate
Risk Aversion and Premium
Intertemporal Choice under Uncertainty and Discrete States
Binomial Model (2 States of Nature for Each Period)
Complete Markets and General Equilibrium, State Prices
Choice under Uncertainty: Infinite States of Nature. Mean-Variance Approach. First and Second Degree Stochastic Dominance
CAPM
Value at Risk and Copulas
Incomplete Markets and Completion Methods
Asset Pricing: General Setting
Risk neutral pricing and no arbitrage conditions
Interest rate structure: Yield Curves
Bond pricing and term structure of interest rates
Mortgages
Duration and Convexity
Clumping and Coupon Clumping
Futures and Forwards: Payoffs
Futures and Forwards: Pricing
Swaps & FRA
Plain-Vanilla Options: Payoffs
Options: Trading Strategies
Plain-Vanilla Options: Monte Carlo and Binomial Pricing
Black & Scholes Pricing and Greeks
Greeks: dynamic portfolio hedging.
Stress Tests.

Miceli, M.A. Dispense sul sito.
Hull, J. “Options, Futures, and Other Derivatives" Possibly 11th Ed. (2021)

Benninga, S. (2014). Financial Modeling. 4th edition, MIT Press.
Campbell, J. Y. (2017). Financial decisions and markets: a course in asset pricing. Princeton University Press.
Cuthbertson, K., Nitzsche, D., & O'Sullivan, N. (2019). Derivatives: Theory and Practice. John Wiley & Sons.
Danthine, J. P., & Donaldson, J. B. (2015). Intermediate Financial Theory. Academic Press. 3rd Ed.
Elton, E.J.; Gruber, M.J.; Brown,S.J. Goetzmann, W.N. (2017) Modern Portfolio Theory and Investment Analysis, Wiley 9th Ed.
Kosowski, R.L. & S.N. Neftci (2015). Principles of Financial Engineering. Academic Press
Resti, A. & Sironi, A.(2007). Risk Management and Shareholders' Value in Banking: From Risk Measurement Models to Capital Allocation Policies, Wiley.
Taleb, N. (1997). Dynamic Hedging-Managing Vanilla and Exotic Options. John Wiley & Sons Inc.

Lectures in the classroom.
Weekly assignments on eLearning ( Moodle).
Computational exercises with the students at the blackboard or through computer programming in Excel / Matlab .

Not mandatory but strongly recommended.

Passing weekly assignments as Quiz on Moodle.
Written exam in class.
Oral exam for written evaluations lower than 20/30 or over 27/30.

Consumer Choice Under Uncertainty
max U(c0,c1,c2) ​​= log(co) + (1/(1+theta) * ( pr1*log(c0) + pr2*log(c2) )
p0*c0 + v1*n1 + v2*n2 = P0*w0; % (VB0)
p1*c1 = p1*w1 + n1*y11 + n2*y12; % (VB1)
p2*c2 = p2*w2 + n1*y21 + n2*y22; % (VB2)
%% Parameters
logU = log(co) + (1/(1+theta) * ( pr1*log(c0) + pr2*log(c2) )
theta = 0.05; % rate of intertemporal preference
pr1 = 0.6; % probability state=1
pi1 = 0; % inflation rate in s=1
pi2 = 0; % inflation rate in s=2
w = [0; 10000; 0]; % Endowments
v = [900; 400]; % asset prices
Y = [1200, 500; 400, 300]; % S x K matrix of payoffs

Compute c2* (0 decimals)

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Yield Curve Bond Quotes
t0 = 0 = today
Quotes
Semi-annual Coupon Maturity Bond P
A 0.5 0 97.35
B 1 0 95.73
C 2 2 99.10
D 5 3 102.16

Compute Spot, Fwd and Swap Rates.
Report swap rate at (3Years)
(3 decimals. For 3.215%, write 3.215)

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Trading Strategy: STRADDLE

The portfolio is made up of:
A Long PUT(S0,K)
A Long CALL(S0,K),
Using the formulas for PUT(S0,K) and CALL(S0,K) in t0 with BS (which I do not ask you to calculate), the prices can be written (in order to organize the quiz) as

P0 = PUT(S0,K1,t0) = mP * K;
C0 = CALL(S0,K2,t0) = mC * K;
Parameters:
S0 = 125;
K = S0;
mP = 0.015; mC = 0.0254;
t0 = 0; T = 3/12;
sigma = 0.1;
rf = 0.05;
u = 0.11 , percentage increase in ST price
Compute the ST break-even point for ST< K.
(3 decimals)

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7-period Binomial Tree
Data:
S0 = 100
Strike = 90
T (years) 7
volatility = 0.3
n Periods 7
r = 0.05
Div-Yield = c = 0
u = ?; d = ? ; q = ?; 1-q = ?;
American PUT Price at t0
(2 decimals)