# Financial Engineering

- Credits: 5
- Ending: Examination
- Range: 2P + 2C
- Semester: summer
- Year: 1
- Faculty of Economic Informatics

## Teachers

## Included in study programs

**Teaching results**

Knowledge:

• Comprehensive elaboration of identification, analysis, guidance and monitoring of financial risks of the enterprise, with emphasis on price risks, credit risks and liquidity/liquidity risks. Based on the quantification of financial risk, propose a strategy aimed at maximising profit, eliminating the selected financial risk or managing the value of the financial investment, with financial and commodity derivatives as supporting instruments.

Competence:

• the ability to describe the steps of a process approach to financial risk management,

• characterise the nature of financial (commodity) derivatives and identify the causal implications of the use of derivatives in the management of selected financial risk,

• effectively set the baseline and monitor the progress of the implementation of a hedging strategy,

• identify the implications of the use of derivative contracts on the financial performance of the enterprise and corporate reporting,

• the ability to propose, present and defend the validity of the chosen strategy to external users of corporate information.

Skill:

• perform basic financial risk identification; quantify the maximum loss, probability of occurrence and exposure period; then link to an appropriate derivative instrument,

• sort out the applicability of derivative instruments to different risk situations,

• quantify the starting value, fair (theoretical, equilibrium) price, fair value and expert price of a derivative contract,

• account for the acquisition, recognition and termination of a derivative transaction in financial accounting, with an emphasis on SAS and IFRS/IAS,

• perform basic impact analysis in the deployment of derivative contracts - application of graphical and computational techniques.

**Indicative content**

Thematic definition of lectures:

1. Introduction to financial engineering

2. World Finance and the Financial Revolution

3. Forward contracts

4. Futures contracts

5. Option contracts

6. Models for determining the option premium for European options

7. Swap contracts

8. Credit (credit) derivatives

9. Specific forms of derivative contracts

10. Determining the fair value of unconditional futures contracts

11. Determining the fair value of contingent futures contracts

12. Accounting treatment and balance sheet treatment of derivative contracts under SAS and IFRS/IAS

13. Process and institutional approach to financial risk management

Thematic definition of exercises:

1. Financial risk

2. Financial revolution and its implications for derivatives

3. Financial investment strategies

4. Forwards 1

5. Forwards 2

6. Futures 1

7. Futures 2

8. Options 1

9. Options 2

10. Swaps

11. Application of credit derivative pricing approaches to credit default prediction

12. Determining the fair value of exchange-traded and over-the-counter derivatives

13. Accounting for derivatives

**Support literature**

Basic literature:

1. MARKOVIČ, Peter a kol. Manažment finančných rizík podniku. Implementácia derivátových kontraktov. Bratislava : Iura Edition, 2007. 383 s. ISBN 978-80-8078-132-3.

2. VLACHYNSKÝ, Karol – MARKOVIČ, Peter. Finančné inžinierstvo. Bratislava : Iura Edition, 2001. 294 s. ISBN 80-8904-7084.

3. BLOSS, Michael et al. Financial Engineering. München : Oldenbourg Verlag, 2011. 608 s. ISBN 978-3-486-59650-2.

4. FARKAŠ, Richard. Účtovná závierka obchodných spoločností. Bratislava : Wolters Kluwer, 2020. 1224 s. ISBN 978-80-571-0247-2.

5. JÍLEK, Josef. Finanční a komoditní deriváty v praxi. Praha : GRADA Publishing, 2005. 632 s. ISBN 80-247-1099-4.

Supplementary literature:

1. ALBRECHT, Peter – HUGGENBERGER, Markus. Finanzrisikomanagement. Methoden zur Messung, Analyse und Steuerung finanzieller Risiken. Stuttgart : Schäffer-Poeschel Verlag, 2015. 584 s. ISBN 978-3-7910-3412-6.

2. DEUTSCH, Hans-Peter. Derivate und Interne Modelle. 4. Auflage. Stuttgart : Schäffer-Poeschel Verlag, 2008. 686 s. ISBN 978-3-7910-2786-9.

3. HULL, John C. Optionen, Futures und andere Derivate. Hallbergmoos : Pearson Deutschland GmbH, 2019. 1064 s. ISBN 978-3-86894-349-8.

4. HULL, John C. Optionen, Futures und andere Derivate. Das Übungsbuch. Hallbergmoos : Pearson Deutschland GmbH, 2019. 356 s. ISBN 978-3-86894-350-4.

5. JÍLEK, Josef. Deriváty, hedžové fondy, offshorové společnosti. Praha : GRADA Publishing, 2006. 260 s. ISBN 80-247-1826-X.

6. WIEDEMANN, Arnd. Financial Engineering. Bewertung von Finanzinstrumenten. Frankfurt am Main : Frankfurt School Verlag, 2018. 578 s. ISBN 978-3-95647-127-8.

7. WITZANY, Jiří. Financial Derivates. Valuation, Hedging and Risk Management. Praha : Nakladatelství Oeconomica, 2013. 374 s. ISBN 978-80-245-1980-7.

**Syllabus**

Thematic definition of lectures: 1. Introduction to financial engineering - general model of risk; definition of financial risk; breakdown of financial risks in terms of influenceability; life cycle of financial risk; definition of nature and forms of financial innovation; basic roles and mission of financial engineering. 2. World Finance and the Financial Revolution - definition of the disruptive changes that led to the intensification of the use of derivative instruments; breakdown of first generation derivatives; characteristics of financial and commodity derivatives. 3. Forward contracts - general characteristics; derivation of the profit-loss profile (buyer and seller motives); breakdown of forwards by underlying instrument (interest rate, currency, equity, commodity). Determination of the equilibrium price of a forward. 4. Futures contracts - general characteristics; derivation of profit-loss profile (buyer and seller motives); breakdown of futures by underlying (interest rate, currency, equity, commodity, index). Determination of the futures equilibrium price. 5. Option contracts - general characteristics; derivation of profit-loss profile (buyer and seller motives) for call and put options; breakdown of options by underlying instrument (interest rate, currency, equity, commodity, other derivatives). Determination of the strike price of call and put options. 6. Models for determining the option premium for European options - Cox-Ross-Rubinstein model; Black-Scholes model and its variations. Option premium sensitivity indicators and their use in modelling changes in the time and intrinsic value of an option. 7. Swap contracts - antecedents (parallel loan and reverse loan); general characteristics of swaps; elaboration of the use of coupon and basis swaps; combination of underlying instruments (currency and currency-interest rate swaps). 8. Credit (credit) derivatives - definition of forms of credit risk and hedging options; characteristics of the nature of contracts - credit default swap, total return swap, credit option. Determination of the value of a credit derivative. 9. Specific forms of derivative contracts - warrants, weather derivatives, combined and synthetic structures (restructuring of building blocks, mutual combination of derivatives, hybrid structures). 10. Determining the fair value of unconditional futures contracts - identifying the derivative claim and derivative liability; determining the fair value of the derivative claim and liability; deriving the fair value of the derivative; transforming the fair value of an exchange-traded and over-the-counter derivative into an appraisal price for the derivative. 11. Determining the fair value of contingent futures contracts - identifying the option receivable and option payable; modelling the probability of potential exercise of the option; determining the fair value of the option receivable and option payable; deriving the fair value of the option; transforming the fair value of the exchange-traded and over-the-counter option into the option's appraisal price. 12. Accounting treatment and balance sheet treatment of derivative contracts under SAS and IFRS/IAS - acquisition date, balance sheet date, settlement date/settlement date. On-balance sheet and off-balance sheet accounting. Application of knowledge of selected standards - IAS 32, IAS 39, IFRS 7, IFRS 9 and IFRS 13. Tax implications of derivative transactions. 13. Process and institutional approach to financial risk management - link to internal audit. Developing a methodological approach to formulating an auditable hedging strategy (identification, analysis, guidance and monitoring) - concentration on the financial risks of the enterprise. Thematic definition of exercises: 1. Financial risk - definition of its essence, quantification of its parameters (maximum loss, probability of occurrence and exposure period); breakdown of financial risks in terms of their impact on the financial flows of the enterprise. Price (interest rate, currency, equity, commodity) risks, credit risks, liquidity and liquidity risk. 2. Financial revolution and its implications for derivatives - internationalisation, globalisation, glocalisation, deglobalisation, deregulation, securitisation, intellectualisation, new technologies. The development of financial innovation. 3. Financial investment strategies - trading (singular, combined), arbitrage (risk and risk-free), hedging (insurance, asset-liability management, derivative hedging), portfolio strategies (optimal portfolio construction, portfolio value hedging). 4. Forwards 1 - position of buyer and seller, graphical representation of the behaviour of contract participants; definition of specific features and regularities of interest rate forwards (FRA, FRA-BBA), currency and commodity forwards. 5. Forwards 2 - transfer cost model and expectation model in valuation of forwards; determination of present and future value of forwards; use of forwards in hedging operations; specific features of forwards on the Slovak market. 6. Futures 1 - position of buyer and seller; graphical representation of the behaviour of contract participants; marking to market; quantification of basis and its forms (theoretical and value); comparison of strike price and fair value of futurity. 7. Futures 2 - transmission cost model and expectation model in forward pricing; determination of present and future value of a forward; basis and its forms; use of futures in arbitrage and hedging operations. 8. Options 1 - buyer and seller positions; graphical representation of the behaviour of the contract participants; call and put options (long and short positions); intrinsic and time value of an option; financial results of option trades under different strategies. 9. Options 2 - option pricing (option premium); identification of the determinants of the time value of an option; mechanism of application of the binomial model in pricing a European option; Black-Scholes model for European options, depending on the underlying instrument. 10. Swaps - mechanism of swap operation (positions of partners); initial assessment of swap suitability; determination of present and future value for coupon and basis swaps; evaluation of the efficiency and effectiveness of swap operations for interest rate and currency transactions. 11. Application of credit derivative pricing approaches to credit default prediction - comparison of option models and their application in uncertain event environments. Identification of other areas of application. 12. Determining the fair value of exchange-traded and over-the-counter derivatives - solving examples with a focus on market pricing or qualified estimation (valuation model). Transformation of fair value into an appraisal price. 13. Accounting for derivatives - definition of the chart of accounts (373, 376, 377, 414, 567, 667); elaboration of off-balance sheet accounting and subsequent treatment of examples of accounting for forwards, futures, options and swaps - at the acquisition date, at the balance sheet date, at the expiration date.

**Requirements to complete the course**

30 % continuous written work, 70 % oral examination

**Student workload**

130 h (attendance at lectures 26 h, attendance at exercises 26 h, preparation for exercises 26 h, preparation for credit paper 13 h, preparation for exam 39 h)

**Language whose command is required to complete the course**

Slovak

Date of approval: 11.03.2024

Date of the latest change: 12.01.2023