FE680 Advanced Derivatives

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Course Catalog Description


This course deals with fixed-income securities and interest-rate sensitive instruments. Topics include term structure of interest rates, treasury securities, strips, swaps, swaptions, one-factor, two-factor interest rate models, Heath-Jarrow-Merton (HJM) models and credit derivatives: credit default swaps (CDS), collateralized debt obligations (CDOs), and Mortgagebacked securities (MGS).
Campus Fall Spring Summer
On Campus X X
Web Campus X X


Professor Email Office
Dragos Bozdog
dbozdog@stevens.edu Babbio 429A

More Information

Course Description

This course will address practical and theoretical issues for interest rate models, credit models, and hybrid instruments.

In the first part of the course we will discuss the methodology and principles behind Interest rate models: Hull White , HJM, Markovian HJM models. Mortgage derivatives and prepayment models will be discussed as an application of the interest rates models.

The second part of the course will be focused on credit models: building discount curves for credit models estimation of default probability and credit spread from equity prices. We will discuss Gaussian copula model, base correlation and CVA. Hybrid Securities will be introduced and modeling issues will be discussed.

Course Resources


Damiano Brigo, Interest Rate Models - Theory and Practice: With Smile, Inflation and Credit, Springer Finance

(ISBN 978-3662517437)

Dominic O'Kane, Modelling Single-name and Multi-name Credit Derivatives, Wiley

(ISBN: 978-0-470-51928-8)

Additional References

John Hull. Options, Futures, and Other Derivatives. 2012. Eighth Edition. Prentice Hall. ISBN: 978-0132164948

Lixin Wu, Interest Rate Modeling: Theory and Practice, Chapman and Hall/CRC Financial Mathematics Series, 1st Edition. (ISBN: 978-1420090567)

Jan De Spiegeleer, Wim Schoutens, Cynthia Van Hulle, The Handbook of Hybrid Securities: Convertible Bonds, CoCo Bonds and Bail-In, Wiley (ISBN: 978-1-118-44999-8)


Grading Policies

Assignments 60%

Final 40%

Lecture Outline

Topic Reading
Week 1 Static curves: Construction of discount factors, zero coupon rates, forward rates. Pricing bonds and interest rates swaps. Bond price sensitivity to interest rates moves (duration, DV01, convexity). Bootstrapping Yield Curve.
Week 2 Interest Rate Derivatives (Convexity, Timing, Quanto Adjustment)
Week 3 Interest Rate Derivatives: The Standard Market Model
Week 4 Interest Rate Derivatives: Models of the Short Rate
Week 5 Interest Rate Derivatives: HJM and LMM
Week 6 Swaps Revisited
Week 7 Credit models: Default event and survival probabilities. Risk neutral and realized default probabilities. Cash flows conditional on default and survival probabilities. Forward default intensity curve. Clean par credit curve. Pricing credit default swaps. Survival probability and recovery values.
Week 8 CDS. Implied hazard rates. Implied default curves.
Week 9 CDO’s: introduction, Gaussian copula models, Large portfolio Approximation
Week 10 Base Correlation framework ; Merton’s Asset Value Model
Week 11 Counterparty Credit Risk and Credit Value Adjustment
Week 12 No Class (Thanksgiving Recess).
Week 13 Hybrid Securities: Convertible Bonds, CoCo Bonds and Bail-In
Week 14 Modeling Hybrids Securities: Advanced Issues