MATH4514 Financial Economics in Actuarial Science
Course Outline
Spring Semester 2023-2024
1. Instructor
Name: Dr. Leung Chi Man (Call me LCM if you wish)
Office: Room 3419 (Lift 17-18)
E-mail: [email protected]
Office hours: 2:00p.m.-3:00p.m. every Thursday
2. Meeting time and Venue
Lecture: Mon 4:30p.m.-6:50p.m. @Room1410
Fri 12:00p.m. - 1:20p.m. @Room1410
(*The tutorial on Monday will also be used as lecture.)
3. Course Description
Credit point: 3 credits
Prerequisites: MATH2421 (Probability) and MATH2511 (Fundamental of Actuarial
Mathematics).
The course aims to study some actuarial models and their application in derivative
pricing and financial risk management. Topics include introduction to financial
derivatives and basic pricing principle, use of options strategies in financial
management, development of Binomial tree models in pricing derivative, Black
Scholes option pricing model, Options Greeks and the numerical algorithm in pricing
derivative under Black-Scholes model.
4. Intended Learning Outcome (ILOs)
Upon successful completion of this course, students should be able to understand
the following topics:
1. Various financial derivatives (forward, futures, options, exotic options and
interest rate derivatives) and their applications in financial management;
2. General properties of options such as put-call parity, general parity and
sensitivity analysis on options price with respect to strike price and time to
maturity;
3. Various options strategies (option spreads, collar, straddle, strangle, butterfly
spread) and their application in risk management;
4. Binomial tree pricing model and its application in derivative pricing;
5. Black Scholes option pricing model and its model assumptions.
In addition, students would also acquire the following abilities:
6. Appreciate the use of various quantitative methods and numerical methods
in derivative pricing.
7. Able to use various financial derivatives to solve problems in financial
management under various scenarios.
8. Able to develop suitable pricing models (Black-Scholes model or Binomial
tree pricing model) using given market data to price various financial
derivatives.
5. Student Learning Resources
We will use our own Lecture notes in this course. Additional problem sets (optional)
will be provided. All materials can be found in canvas (https://canvas.ust.hk )
The following reference books will be useful:
1. McDonald, Robert, L. (2014). Derivatives Markets, 3rd ed. Pearson (ISBN 10: 1-
292-02125-X).
(*Remark: This book covers all contents taught in this course.)
2. Hull, John (2014). Options, Futures, and Other Derivatives, 9th ed. Prentice Hall
(ISBN-10: 013345631).
6. Teaching and Learning Activities
Lectures (4 hours per week)
7. Tentative Course Schedule
Chapter 1: Introduction to Financial derivatives
- Forward contract, Pre-paid forward contract and Future contract
- Determination of forward price using no arbitrage pricing principle.
- Introduction to options and basic pricing principle
- Properties of options price: Put-call parity on European options, monotonicity
and convexity of options price.
- Options strategies and their applications.
- American options and early exercise strategy of American options
Chapter 2: Binomial tree pricing models
- Single period Binomial tree model: Derivative pricing using no arbitrage pricing
principle and risk neutral valuation principle.
- Multi-period Binomial tree model and its applications in pricing American
options and path-dependent derivatives (Barrier options, Asian options,
Lookback options etc.)
- Construction of binomial tree pricing model using market stock data – Forward
binomial tree, Cox-Ross-Rubinstein tree and Lognormal tree
- Binomial tree model on dividend paying stock.
Chapter 3: Black-Scholes option pricing model
- Basic model setup and model assumptions
- Ito’s lemma and lognormal distribution for stock price process
- Black-Scholes formula on European call/put options and its derivation.
- Options Greeks, concept of implied volatility.
- Risk neutral valuation principle and its application in derivative pricing.
- Numerical methods – Lattice tree algorithm and Monte-Carlo simulation
8. Assessment Scheme
There are 3 assessment tasks in this course:
Weight CILOs assessed
Assignment 15% + Bonus 1, 2, 3, 4, 5, 6, 7, 8
Midterm Examination 20% 1, 2, 3, 4, 5, 6, 7, 8
Final examination 65% 1, 2, 3, 4, 5, 6, 7, 8
(a) Assignment (15% of the total grade + Additional Bonus)
There are required problems and optional problems in each of the assignments.
You are required to complete all required problems. Also, you may complete
some optional problems for bonus score (which may improve your final grade).
(b) Midterm examination (20% of the total grade)
It will be in-class 1.5 hours closed-book exam. The details will be announced
later.
(c) Final Examination (65% of the total grade)
It will be a 2.5~3 hours closed-book exam. The exam will cover all materials
taught in the course. The exam date and venue will be scheduled by ARR. The
exam format will be announced in the last class of this course.
(*Note: You can pass the course for sure if you get at least 40% overall in this course and
get at least 25 points (out of 100) in the final exam.)
(**Note 2: Your final grade will be determined based on absolute grading scheme)
