Syllabus ESB / IB Program

Quantitative Finance/Economics
and Financial Engineering
By Professor Herzog

I. Overview
This course will provide an overview of quantitative methods in finance and
economics. We study financial engineering and pricing of derivatives plain vanilla
and exotic options. The course introduces state-of-the-art models in mathematical
finance. Ill illustrate the key working principles of these models and you will learn
how to apply these models.

II. Professor & Course Information

Instructor: Professor Dr. Bodo Herzog, IB-Team, ESB Business School, Germany
Teaching & Research: Macroeconomics, Monetary Theory, Mathematical Finance
Email: Bodo.Herzog@Reutlingen-Universtiy.de
WEB: http://www.esb-business-school.de/en/business-school/organisation/professors/herzog.html
IFE-WEB: http://www.ife-reutlingen.de/
Office hours: open door policy Room: 5-108
Course homepage and e-learning: RELAX
Course Hours: 4 hours per week (but blocks with 4 to 6 SWS per week)
Workload for students: 150 hours, 50 hours lecture, 100h self-study

III. Teaching Methods

I will present the insights of quantitative finance and economics, but emphasize the
application of theory to public and private decision-making. Each session will involve
class discussions. You must be prepared to every lecture. Throughout the semester,
extensive papers will be distributed; these are intended for students preparation and
consolidation of the course material. In all sub-areas, homework sets will be
distributed as well; these will be processed and prepared by students individually or
in groups! In some instances, discussion will be centered on general issues; in others
it will be centered on special cases. Your participation is critical to the success of the
course.

IV. Course Goals and Objectives

Students will be familiar with current internationally accepted financial economic
concepts. Moreover, they are able to understand and apply theoretical models and
empirical studies taken from the latest official national and international economic
and financial databases.

Students will have the persistence, integrity, and maturity to develop advanced
tools that can be used responsibly and fully appropriate to the problem in hand
Students will evaluate and manage complex financial instruments in national and
global contexts
Students will implement their models in reliable and useable software solutions
Students will effectively communicate difficult quantitative solutions to nonspecialist users

The goals in my course are threefold:

1. Learning how to think analytically and learning how to approach problems
2. Learning the key concepts and models in quantitative finance and economics
3. Learning how to analyse current financial products and strategies (hedging)
Overall its about learning how to learn and having fun!

By the end of this course, you should have:

An understanding of the functioning of options;
An understanding of hedging strategies;
An understanding of the working of financial engineering;
An understanding of how to compute the price of an option (BS-Formula);
An understanding of modelling asset market dynamics;
An understanding of supply and demand in bond markets;
An appreciation of the functioning of stochastic differential equations;
An understanding about the limits of financial mathematics;
An understanding of the subprime crisis, the European debt crisis (CDOs);
A profound knowledge about the working of models in quantitative finance;

Main Competencies: Students will engage in critical thinking and analyse issues
with a global mindset.

V. Course Outline: The Big Picture

1. Introduction
2. Concept of Finance and Financial Engineering
2.1 Products: Futures, Forwards and Options (Focus)
2.2 Application to Hedging (for instance exchange rate risks)
2.3 Design of New Products and Hedging Strategies
3. Statistical Foundation: A brief Recap
4. Introduction to Stochastic and Mathematical Finance
4.1 Brownian Motion
4.2 Stock Market Modeling with Stochastic Differential Equations (SDEs)
4.3
5. Pricing of Options
5.1 Black-Scholes Formula (BS-Formula)
5.2 Extensions of BS-Model
5.3 Exotic Options
6. Current Issues (Bond Market Crisis, Sovereign Debt Crisis,)

VI. Readings
The literature for the course is based on my own lecture notes. Please get in touch
with the recent edition. In addition, it is also suggested that students get into the habit
of the following daily newspaper The Wall Street Journal, The Financial Times,
Frankfurt Allgemeine Zeitung, or Handelsblatt. Highly recommend is the weekly
magazine The Economist at least a couple of times a month. All sources offer good
and well-written coverage of economic events, and will provide some context for the
course.

VII. Textbooks
Major Literature
[1] Herzog, B. (2014), Financial Economics and Financial Engineering, Lecture
Notes, ESB Business School, Germany. (Mandatory Reading!)
[2] Miranda, M.J. and P.L. Fackler (2002), Applied Computational Economics and
Finance, The MIT Press.
[3] Neftci, S.N. (2009), Principles of Financial Engineering, Academic Press.
[4] Wilmott, P. (2006), Paul Wilmott on Quantitative Finance, Wiley.
[5] Ruppert, D. (2010), Statistics and Data Analysis for Financial Engineering,
Springer Verlag.
[6] Stefanica, D. (2011), A Primer For The Mathematics of Financial Engineering, FE
Press, New York.

Advanced Literature (Master & PhD)

[1] Cinlar, E. (2010), Probability and Stochastics, Springer.
[2] Gnther, M. and A. Jngel (2003), Finanzderivate mit MATLAB, Vieweg. (Book is
available as eBook in University Reutlingen Library).
[3] Mao X. (2011), Stochastic Differential Equations and Applications, 2 nd Edition,
Woodhead Publishing.
[4] Neftci, S.N. (2000), An Introduction to the Mathematics of Financial Derivatives,
Academic Press.
[5] Oksendal, B. (2007), Stochastic Differential Equations, Springer.
[6] Rogers L.C.G. and D. Williams (2011), Diffusions, Markov Processes and
Martingales, Cambridge Mathematical Library.
[7] Ruppert, D. (2010), Statistics and Data Analysis for Financial Engineering,
Springer Verlag.
[8] Seydel, R.U. (2009), Tools for Computational Finance, Springer.
[9] Shreve, S.E. (2004), Stochastic Calculus for Finance I and Finance II, Springer.
Background Literature & Readings of General Interest in Finance/Mathematics:
[1] Allan H. Meltzer (2012), Why Capitalism?, Oxford University Press.
[2] Barth, Caprio, and Levine (2012), Guardians of Finance, MIT Press.
[3] Du Sautoy, M. (2004), The Music of the Primes, Book & DVD, Harper Perennial
and BBC.
[4] Mishkin, F.S. (2009), Economics of Money, Banking and Financial Markets,
Business School Edition.
[5] Shiller, R. (2012), Finance and the Good Society, Princeton University Press.

VIII. Prerequisites
Basics in Economics, Business, Econometrics, Mathematics and Statistics

IX. Assignments, Exams, and Grades

The course grades will be based on homework and your oral performance during
class discussions and discussion of homework. The grade will be determined by 80%
of a mid-term, quiz, and homework, 15% of the class discussions and 5% of the
feedback on lecture notes. You must pass all parts with 4.0 to pass the whole
course/module. Log-In on RELAX is mandatory. For students who are on the border
4

between two grades, performance on class discussions can result in the higher
grade, while failing a discussion can result in a lower grade.

X. Policy on Homework Sets and Examinations

Homework sets are designed to help you learn how to apply the material
presented in lectures and recitations. You are encouraged to discuss course
material, including homework, with other students in the class. With respect to
your final grade, you will get full credit for the assignments as long as you
particpate in all class discussions and pass the exam. The purpose of this
policy is to ensure that homework is a risk-free learning opportunity, but also to
signal our very strong belief that doing the homework is really an essential part
of the learning experience for this class.

Handwritten exams are fine, as long as they are legible and neat. Please
remember: if we can't read it, we can't grade it.

Examinations: During exams, you may consult the proctor administering the
exam if you need clarification of exam questions. No discussion or other form
of communication with anyone else will be permitted after the exams have
been handed out, until all students have turned in their exam books. Students
found to have cheated or engaged in any other unethical behavior will be
given a grade of F on the examinations involved, and will be turned over to the
appropriate disciplinary committees within ESB Business School for further
action. Students arriving late will not be given extra time.

Calculators in Examinations: The only calculators permitted in exams are

those with basic mathematical functions. Calculators that are capable of
handling text may not be used in exams.

If you have any questions about these policies, please raise them in the first or
second lecture.

XI. Student Conduct

Professional conduct is built upon the idea of mutual respect. Such conduct entails
(but is not necessarily limited to):

Attending the Class: Core classes are required for a reason, and each class
benefits from the attendance and participation of all students. Please get
engaged as much as possible questions are always welcome. Of course, the
quality of your comments is more important than the quantity. Your grade for
participation will be affected by nonattendances. You should sit in the
appropriate seat, if relevant, and display a legible name card at all times.
Arriving on Time: Late arrivals are disruptive to both lectures and class
discussion, and show disrespect to those who are on time.
5

Minimizing Disruptions: All cell phones, hand-held devices, and pagers

should be turned off during class. You should not leave and re-enter the class.
You should avoid engaging in side conversations after class has begun.
Being Prepared for Class: You should be ready to discuss any assigned
readings and to answer any assigned questions for each day's class, including
being ready to open a case assigned for that day.
Respect: You should act respectfully toward all class participants. Class
participation grading reflects student adherence to these principles.

XII. Further Details

This course is designed to be partly time-consuming and challenging. The course is a
combination of lectures and case discussions. Class attendance and participation is
critical to the learning process.
Course Policies are Designed to Ensure Fairness. My goals are to meet the
course objectives and to ensure that the course is graded fairly. I will work hard to
ensure that the same partial credit is allocated to the same partially correct answer
on each exam. Occasionally, we will make mistakes in our grading, and we are eager
to correct mistakes. By remaining enrolled in the course, you agree to abide by the
policies detailed above and below. If you anticipate that you cannot abide by these
policies (e.g., because you know that you have a conflict with an exam because of
vacation travel), please either re-arrange your schedule or arrange to take this course
another time.
Exams cannot be rescheduled or made up. Treat these dates as you would an
important meeting in the business world that means that unless you are actually
hacking-up a lung, you had better be there. In the unlikely event that you are faced
with unforeseeable and unavoidable circumstances that will cause you to miss the
exam you must talk to me immediately.
Special Arrangements and Exam Conflicts. If you have a documented disability
(including diseases) and anticipate the need for accommodations in this course,
please make arrangements as soon as possible with me. Documented evidence that
you were seriously ill or had a serious emergency at the scheduled time of an exam
are the only valid excuses for missing an exam. In order to be excused from an
exam, you must contact me prior to the exam immediately and be ready to
provide me with documentation (from an official HS-Reutlingen Amtsarzt).

XIII. E-Learning
Our e-learning platform is RELAX. Please log-in as soon as possible. Enrolment
deadline is immediately after start of the semester.
Enrolment Deadline: TWO weeks after start of semester!
6

Enrolment key:

announcement in lecture!