This document provides an introduction to speculative markets, derivatives, and financial engineering. It defines speculative markets as markets that deal in derivative securities to manage financial risk. Derivatives derive their value from underlying assets and are created through financial engineering. Financial engineering is designing innovative financial instruments and processes to provide customized solutions to firms' financial risk management problems, such as interest rate and currency risk. It involves creating new securities and organizations through applying advances in related technologies. Financial innovation meets demands for risk sharing and transfer and lowers transaction costs.

1. Introduction to
Derivatives and Risk
Management
Speculative Markets

2. Outline
 Meaning of Speculative Markets
 Meaning of Derivatives
 Meaning of Financial Engineering
 Types of Derivatives
 Role of Derivatives
 Sequence of this course

3. Speculative Markets
 A market that deals in derivative securities
such as options, futures, swaps, and variants
of these products
 Why speculative markets?
 To deal with financial risk management
 What are derivatives?
 A financial instrument that derives its value from
the underlying asset on which it is written

4.  Derivatives are the result of financial
engineering
 What is financial engineering?

5. Meaning of Financial
Engineering
 The design, development, and the implementation of innovative
financial instruments and processes, and the formulation of
creative solutions to problems in finance
 Objective is to provide custom-designed solutions to problems
that firms face in the area of financial risk management. Firms’
exposure to financial risk management include interest rate risk,
currency risk, commodity price risk, security price risk, and so on.
 Financial engineering is the means to implement financial
innovation

6.  What is financial innovation?
 Include not only the creation of new types of securities, but
also the development of and evolution of new financial
organizations
 Financial engineering embodies many of the skills, techniques,
and processes that produce both new securities and new
financial organizations.
 It is the application of advances in related technologies that
permit the diagnosis, analysis, design, production, pricing, and
customization of solutions to problems in finance

7. Why Financial Innovation?
 Revolutionary changes in the international financial
system
 Round the clock trading Tokyo-London-New York
 Financial futures, swaps, mortgage-backed securities,
exchange traded options
 Junk bonds
 Shelf registration, electronic funds transfer and security
trading, NOW accounts, asset-based financing, LBO, etc.
 Proliferation of organized trading markets in both
equity and fixed-income derivative securities during
the past two decades is unprecedented

8. What does financial innovation
do for the markets and
participants?
 Meet demands for “completing market” with expanded for
 risk-sharing
 risk-pooling,
 hedging, and
 intertemporal or spatial transfer of resources that are not
already available
 Lower transaction costs/increase liquidity
 Reduce agency costs caused by asymmetric information
 Price Discovery
 Greater Market Efficiency

9. Course Sequence
 Option Markets
 Structure
 Principles
 Pricing
 Strategies—basic and advanced
 Futures Markets
 Structure
 Principles
 Pricing
 Strategies
 Swaps and Other Exotic Instruments