FINS3636 Course Outlines | Interest Rate Risk Management | UNSW Business School
FINS3636 Interest Rate Risk Management - 2021
​The aims of this course are to expose the students to a variety of interest rate products and help them understand how to price them, and when to use them for hedging. There are several reasons why a course in fixed income securities and interest rate derivatives is so useful. First, in general, derivative securities, including interest rate derivatives, can be quite risky. In some cases, firms have lost millions and even billions of dollars in interest rate derivatives. It is important to understand their riskiness. Second, interest rate derivatives are mathematically sophisticated, even more so than equity derivatives. For example, there is not just one interest rate; there can be a different interest rate for each maturity, known as the term structure of interest rates. So, it is important to know how to price interest rate derivatives correctly. Finally, interest rate products are very popular. World-wide, there are trillions of dollars invested in interest rate derivatives. Upon completion, students are expected to understand the mechanics of buying, selling, exercising, and settling the interest rate derivative instruments and other products discussed in the class, determine the value of these instruments, and use them to manage financial risk. By the end of this course, you should be able to: • Understand how measures of duration can be used in risk management,• Understand the uses of and pricing of a variety of interest rate products, including futures, swaps, options, caps, floors, etc.,• Understand how Excel can be used to price many of these products,• Understand the fundamentals of mortgage-backed securities.
This course has FINS2624 (Portfolio Management) as a prerequisite. Some of the topics discussed in FINS3635 (Options, Futures, and Risk Management) may benefit students taking FINS3636, but FINS3635 is not a prerequisite. We have attempted to keep overlap between the two courses to a minimum. As a result, you can take either course independently of the other, in either order. Students interested in quantitative topics may particularly appreciate FINS3635, FINS3636, FINS3640, FINS3641, and FINS3642. Students also need to be able to use a word processing package (such as WORD) and a spreadsheet (such as EXCEL). Some quantitative skills such as basic mathematical ability in dealing with algebraic manipulation are expected.
Understand the basics of bond pricing, duration and convexity, as well as duration-based portfolio management.
Understand the term structure of interest rates—that is, the relationship between a bond’s yield and its maturity—as well as the term structure of volatilities, and the relationship between a bond’s volatility and its duration.
First Computer Assignment
Understand interest rate futures and forward contracts and their market conventions, using them for hedging, defining an optimal hedge ratio, and pricing them using no-arbitrage arguments.
Understand interest rate swaps, including the comparative advantage argument, the pricing of floating rate debt, and the valuation of swaps.
Understand how to model interest rates and bonds using binomial trees, based on delta-hedging (no-arbitrage) arguments, and risk-neutral pricing.
Understand how to price options on bonds using binomial trees, as well as Black’s formula, with volatility depending on the bond’s duration. Also, understand how to price caps, floors, collars, swaptions, and other related securities.
Second Computer Assignment
Understand how to price options on zero coupon bonds and coupon bonds using the Hull-White model, which is similar to Black-Scholes, but with mean-reversion in the risk-free interest rate.
Understand how to price mortgage-backed securities, including the timing risk due to the prepayment option. Understand some derivatives on mortgage-backed securities, such as interest-only and principle-only strips, and collateralised mortgage obligations (CMOs).
Understand features of corporate bonds, such as callability, convertibility, sinking fund provisions. Also, understand the Merton model of risky debt, the dilution effect caused by convertible debt and warrants, and the key features of CDSs and CDOs as well as the role they played in the global financial crisis.
Understand the definition of Value-at-Risk and apply it to bonds and options.
Lecturer-in-charge Dr David Colwell Room 367, UNSW Business School building - Ref E12 +61 2 9385 5851 Thursdays 3:00-5:00pm (or by appointment)
​To get to Dr. Colwell’s office, Please use the East wing elevator (closer to the bookstore), find the phone pad next to the glass door, hit the # key (i.e., “on”) and dial my extension: 55851. I’ll come open the door for you.
The course will be Online this term, so I won't be in my office. I will have a Zoom link available during my consultation hours.
​This course provides the basis to analyse and solve a variety of problems related to interest rate products. The course consists of weekly three-hour lectures. The lecture notes will be available before class, so that students can have an overview of the topics in advance. During the lecture, we discuss the details of the lecture notes, and answer various questions that are left unanswered in the notes. We discuss the intuition behind results and regularly refer to the “big picture” issues, of how each topic relates to other topics. Questions and discussion in class are welcome. Practice problems will be available for each chapter, and doing these should help students prepare for the exams as well as the spreadsheet assignment. The assessments will be based on the lecture notes and practice problems.
​In order to obtain the full benefit from the course, students are expected to follow the following points below: Read the relevant lecture notes before the lectures. This will make it easier for students to follow the lectures and to ask questions. Attend class lectures.Participate in the lectures, asking questions and answering the occasional questions posed by the lecturer. Review the lectures after class.Do the practice problems or take-home assignment when available. If any issues are still not clear, ask me, send me an e-mail, or come to my office during my consultation hours.
NOTE: The timing of the lectures is only approximate. If we do not finish a topic one week, we will continue with that chapter the following week. Also, if we finish a topic early, we will go right to the next topic. Usually, you will need to bring two sets of lecture notes to a given lecture. Each week we’ll try to let you know what you’ll need to bring the following week.
Saturday of Week 4
Exams will be Online. The exams will be multiple choice. (See details below.) The exams are based on material from the lecture notes and practice problems.
The mid-session exam will be held on the Saturday of Week 7. The exam will cover material right up to and including Chapter 9. If applicable, students should notify their employers of the requirement to attend exams. Failure to show up at the exams does not automatically lead to reassessment.
The exams are not learning tools and will not be returned to students. If you have questions about your performance on the mid-session, see the lecturer during consultation hours.
The final exam does not directly cover the chapters covered by the mid-session exam.
The assignments will be based on a number of spreadsheets that will be provided to the students. The details will be described on Moodle under the assignment segments. The first assignment should be relatively quick, and only involves one spreadsheet. For the first assignment, each student will hand in their own assignments. The second assignment is mostly based on material from the second half of the course, and so will only be made available during the last three weeks of session. It is a group assignment (groups of size =< 4). Students will choose their groups themselves.
In Term 3, exams will be ONLINE. To avoid collaboration between students, we have to follow certain procedures:
The exams will be multiple choice exams.
The questions will be in a random order, and different students may have different questions.
You cannot come back to a previous question. (sorry)
You can email me during the exam if you have questions.
​For the assignments, we will use the Assignment link in Moodle. Assignments submitted late will have marks deducted (10% of the total marks per day).
​The website for this course is on Moodle Lecture Notes The only required text is the lecture notes. The lecture notes and important announcements will be available on UNSW Moodle. Practice problems with solutions will also be made available on the course website. The assessments for this course are primarily based on the lecture notes and practice problems.
Sundaresan, S. (2009), Fixed Income Markets and Their Derivatives, 3rd Edition, Southwestern.
NOTE: the lecture notes were originally based on Sundaresan’s book, but the textbook is not required reading. Copies are available in the library if needed.
Hull, J.C. (2015), Options, Futures, and Other Derivatives, 9th Edition, Prentice Hall.
Hull, J.C., S. Treepongkaruna, R. Heaney, D. Pitt, D. Colwell, (2014), Fundamentals of Futures and Options Markets, (Australian edition) Prentice-Hall.
For example, previous student feedback suggested that the lecturer spoke too quickly, and so he has attempted to speak more slowly and clearly.​
Note: the timing of the topics is only approximate. Whenever I finish one chapter, I'll go right to the next chapter.
Treasure Futures & Swaps
Binomial Trees (Chapter 9)
Options #1 (binomial pricing, Black’s formula, options on coupon bonds)
Options #2 (caps, floors, FRAs, inverse floaters, etc.)
Options #3 (Hull and White)
Corporate Debt & Value-at-Risk
Group assignment due.
Term Break: 22 November
Exams: 06 December