FINANCIAL RESPONSE

As mentioned in class, the story of options and the development of the Black-Scholes formula is intertwined with the story of financial markets and institutions and financial crisis.

In addition to the development of the B-S formula, the video brings together many concepts that we have seen in class this semester, including (in no particular order):

– Replicating portfolio and no-arbitrage pricing

– Market efficiency vs. beating the market

– Statistical methods for characterizing returns and measuring risk

– Risk transfer role of derivatives and hedging

– Financial markets: derivatives trading and exchanges

– Financial institutions: investment banks, hedge funds, and the Fed

– Financial crisis

o Excessive leverage

o Government bailouts and moral hazard

The video also gives a great glimpse into the world of academic finance, as well as international financial markets and global crises, notably the Asian financial crisis of 1997 and Russian debt default of 1998. While we have not dealt explicitly with international aspects, you will quickly note the similarity between what got us into trouble back then and what got us into trouble today (e.g., excessive debt/leverage to fuel a property boom, underassessment of risk and/or overconfidence in our ability to deal with risk, government bailouts, etc.).

Choose any five (5) of the bullet points above and discuss the topic further by describing what we learned in class about the topic and linking it to specific parts of the video in which it is mentioned or occurs. A two to three paragraph discussion for each point should suffice, totaling 2-3 pages for the entire assignment.

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