This course is available on the MSc in Finance (full-time), MSc in Finance (full-time) (Work Placement Pathway), MSc in Finance and Economics, MSc in Finance and Economics (Work Placement Pathway), MSc in Finance and Private Equity and MSc in Finance and Private Equity (Work Placement Pathway). This course is not available as an outside option to students on other programmes. This course uses controlled access as part of the course selection process. For information on controlled access courses, including eligibility, application processes, deadlines, and departmental contact details, please refer to the Controlled Access Courses webpage.

All students on a programme listed above will be given a place. The course is not capped.

Please contact finance.teachingmanager@lse.ac.uk with any queries.

This course does not permit auditing students.

Co-requisites:

Either before taking this course, or in the same year as this course, students must complete:

FM436

or

((FM422 or FM422E) and (FM423 or FM423E))

.

Additional requisites:

This course is at the more technical end of the department’s elective courses. Students will be expected to be familiar with calculus, Taylor expansions, and basic concepts from probability and statistics.

Market participants like to talk about “market-implied expectations” in various contexts. CDS rates are used as measures of expected default probabilities; breakeven inflation is used as a measure of expected inflation; forward rates are used as measures of expected future interest rates; implied volatility is used as a measure of expected future volatility. Technically, these are “risk-neutral” measures: CDS rates reveal risk-neutral expected default rates, breakeven inflation reveals risk-neutral expected future inflation, and so on. The course will explain what this means, and how these quantities relate to the true measures of expected default rates, expected inflation, etc, that we would really like to know. Along the way, it provides a thorough grounding in derivative pricing and hedging, including option pricing and the dynamic replication logic that underpins the Black-Scholes formula. As the underlying assumptions required for this all to work can fail to hold (and have famously failed, for example, during the great crash of Black Monday, 1987, and during the subprime crisis of 2008-9), we will for the most part emphasise a different view of the world, taking option and other derivative prices as given, and exploring how these prices can be used to forecast movements in financial markets.

30 hours of seminars in the Winter Term.

This course is taught in an interactive format. There is no distinction between lectures and classes/seminars; there are simply “sessions” where the pedagogical approach is always interactive.

Based on a set of lecture notes and selected journal articles. No one book covers the material of the entire course, but Derivatives Markets by Robert McDonald or Options, Futures and Other Derivatives by John Hull might be useful as background reading. Ian Martin's survey paper “Information in Derivatives Markets: Forecasting Prices with Prices”, forthcoming in the Annual Review of Financial Economics, gives an overview of some of the ideas covered.

Continuous assessment (100%).