FE625 Emerging Markets: Risks and Models
Course Catalog Description
This course covers the basics of Emerging Markets (EM) instruments, models, risks, hedging and trading practices.
The course is based on two pillars: first the basic concepts on the models and market are introduced; second the
implementation and use of those concepts in real life examples and simulation of a trading environment
Throughout the course there will be an emphasis on market conventions and practitioner best practices. One of the
main objectives involves a have hands on approach into managing the valuation, risks, proper hedges and dynamics
of a real book. To this end the student will be given as a starting point a spreadsheet that simulates a system
for managing a book of FX contracts in the real world. The name of this spreadsheet system is: MiniSystem. The
student will then be asked to develop the pricing models in the system to include different types of contracts,
to value them, to calculate the relevant risks, to explain the changes in the valuations and to calculate the
proper hedges. This approach will initially be done on individual contracts and then in aggregate for a whole
book of contracts.
The main four objectives of the course are:
- 1- Academic: For the students to acquire theoretical knowledge in EM models, conventions and main
differences with developed markets
- 2- Practice: For the students to be able to price, execute and hedge options and a book in FX market
including a smile effect as is done in practice
- 3- Insertion: Provide the students with tools for their insertion into the labor market with some of the
latest information on hiring process, interview tips and market trends
- 4- Exposure: Expose the students to market participants and give them an opportunity to interact with them
Recommended: 1- Investing in Emerging Markets Fixed Income Markets, Frank J. Fabozzi, 2002, ; 2- Counterparty
Credit Risk and Credit Value Adjustment, Jon Gregory, 2012, Wiley (2nd edition) ; 3- Dynamic Models and
their Applications in Emerging Markets, Sima Montamen-Samdian,, 2002, ; 4- Published papers and working
Published papers and
- Homework – 40%
- Class Interaction – 20%
- Final Projects (2 to 3) – 40%
||General Introduction to Emerging Markets. Definitions, volumes,
geography, types and brief history. Cycles of growth and crisis. Correlation between countries and regions.
||Fixed income instruments overview I : Interest rates swaps, FX
forwards. Introduction, definitions, trading properties (liquidity, conventions, etc), risks and pricing.
||Fixed income instruments overview II : credit default swaps,
swaptions, FX options. Introduction, definitions, trading properties (liquidity, conventions, etc), risks
||Future expected mark to market. Future expected credit exposure.
||Introduction to capital constraints as a form of economic policy.
Convertibility, transferability and default risks. Financial instruments designed for this risk, their
modeling and valuation
|| Cross Currency Swaps: introduction, definition, use as funding
instruments, cross currency basis swaps and risks
||Inflation instruments in Emerging Markets. Inflation currencies and
inflation indexes. Inflation Swaps: modeling, pricing an valuation. Deliverable currencies vs
||Credit Risk for Emerging Markets. Country ratings and local ratings. Country risk. Bonds as as hybrid instruments (IR risk + Credit risk).
||Hybrid instruments: Quanto CDS, extinguishable swaps and CVA. Call/Put parity between CVA and extinguishable swaps.
||Class I: 4 Factor Model with FX jumps. Model motivation and derivation. Presenting the analytical solution
||Class II: 4 Factor Model with FX jumps. Getting the Analytical solution. Analyzing the model through its analytical solutions. Limits and behaviors
||Funding and collateralization of derivatives I: Introduction to CSA and ISDA terms. OIS discounting.
||Funding and collateralization of derivatives II: Determining the value of the CSA Thresholds. Netting and Set-off. Cheapest to Deliver (CTD).