EBF 473

Risk Management in the Earth Sciences

EBF 473, Fall 2018

Risk Management in the Earth Sciences: Analysis of strategies for mitigating business risk from market, atmospheric, geophysical uncertainties including the use of energy/mineral commodity futures/options, weather derivatives, and insurance.

Class Time and Place: Tuesdays and Thursdays, 1:35-2:50 pm, 358 Willard

Instructor: Zhen Lei, [email protected], 125 Hosler Building
Office Hours: 9-12 pm, Mondays

Teaching assistants: Zhongyang He: [email protected]
Office Hours: 2:30-5:30 pm, Wednesdays, 214 Hosler

Notes: I have “official” office hours on Mondays 2-5 pm, but I am happy to chat with you at other times if you cannot make it. When I’m not around, the best way to communicate with me is to send email to me at [email protected]. Please note that I do not read my CANVAS mail regularly.
Course Overview

All major firms engage in financial risk management. In this course, we will learn the basics of how firms can use financial instruments to manage their financial risk. In particular, we will focus on risk management with respect to threats to financial viability from the weather. This course will be both challenging and highly practical.

Prerequisite: EBF 200, EBF 301, MATH 141, STAT 301 or STAT 401 or EBF 472

Text: John C. Hull, “Options, Futures, and Other Derivatives” (any edition from 6th onwards is fine). The EMS library has one copy in reserve.

Course Objectives

This course is designed to give you the basic underpinnings of financial risk management and help prepare you for a career in this area. Specific topics reviewed include:

  1. Properties of options
  2. Basic financial statistics
  3. Arbitrage (making money without investing money)
  4. Determining the value of options
  5. How to use options to reduce financial risks.

Understanding each of these areas is important for a successful career in the energy industry.
An additional goal for this class is for you to become more familiar with how to present your work in a professional manner. Thus, all answers will be expected to be complete, and all work fully shown.

Course Content

Topic/Readings

  • Review of Financial Statistics: Lecture notes
  • Mechanics of Options Markets: Hull (9th edition), Chapter 10
  • Financial Statistics and the Collapse of Long-Term Capital Management (1998): “Long-Term Capital Mismanagement,” pages 218-274 in Marthinsen, Risk Takers
  • Properties of Stock Options: Hull (9th edition), Chapter 11
  • The Binomial Option Model: Hull (9th edition), Chapter 13
  • The Black Sholes Model: Hull (9th edition), Chapter 15
  • Midterm
  • Delta Hedging, Nick Leeson and the Collapse of Barings Bank (1994), and Delta-Gamma Hedging: Chapter 19, Hull (9th edition), Kolb and Overdahl, pages 142-147
  • Implicit Volatility and the Volatility Smile: Hull (9th edition), Chapter 15.11, Chance
  • Going Short and the 1999-2000 Internet Bubble: Lamont, “Short-Sale and Overpricing”
  • Mortgage Backed Securities and the Collapse of 2008: Buckberg, et. al.,” Subprime and Synthetic CDOs: Structure, Risk, and Valuation”
  • Weather Derivatives: Considine, “Introduction to Weather Risk Management”, Young, “Pricing Electricity from Probabilistic Weather Forecasts”, In Nature’s Casino by Michael Lewis: http://www.nytimes.com/2007/08/26/magazine/26neworleans-t.html?pagewanted=all&_r=0

All readings outside the Hull text will be posted on the course CANVAS site.

Important Dates (subject to change)

  • August 21 (Tuesday): First class
  • October 25 (Thursday): Midterm
  • November 18-24: Thanksgiving Holiday
  • December 6 (Thursday): Last class
  • Final Exam: TBA

Grading mistakes happen. So if you think your work was graded incorrectly, please ask the instructor. But make sure to check with the grader first. This saves a lot of trouble.

Assessment Tools (i.e. Grading policy, written assignments and examination policy)

  • Homework (5-6) 35%
  • Quizzes 15%
  • Mid-term exam 25%
  • Final Exam 25%

Grade: Weighted Score
A, A-/90-100
B+, B, B-/80-89
C+, C/70-79
D/60-69
F/0-59

The mid-term and final will be closed book, no notes. The final will be cumulative.

Your homework grade will be calculated as the average of the 5-6 homework scores. Please type your homework and submit them in paper form using one side of the page (no electronic submissions), showing all your work. Graphs should be done using EXCEL. Also, you should familiarize yourself with the EXCEL “COPY” command. No late homework will be accepted.

It is very important to keep up to date on the material. Trying to “cram” in the class work right before an exam will not be successful. To give you additional incentives to keep up with the class, most class periods will end with a short quiz. These quizzes will be open book, open notes. Quizzes will be based on the most important points from the previous class’ lecture. Thus, it should be straightforward to figure out what is likely to be on these quizzes. Put another way, if you are surprised by a question on a daily quiz, you most likely have made a mistake.

Please bring a calculator to class every single session.

Academic Integrity
Students in this class are expected to write up their problem sets individually, to work the exams on their own, and to write their papers in their own words using proper citations. Class members may work on the problem sets in groups, but then each student must write up the answers separately. Students are not to copy problem or exam answers from another person's paper and present them as their own; students may not plagiarize text from papers or websites written by others. Students who present other people's work as their own will receive at least a 0 on the assignment and may well receive an F or XF in the course.

Please see: Earth and Mineral Sciences Academic Integrity Policy: http://www.ems.psu.edu/undergraduate/academic-advising/forms-and-procedures/academic-integrity, which this course adopts. To learn more, see Penn State's "Plagiarism Tutorial for Students."

Students with Learning Disabilities

Penn State welcomes students with disabilities into the University's educational programs. Every Penn State campus has an office for students with disabilities. The Office for Disability Services (ODS) website provides contact information for every Penn State campus: (http://equity.psu.edu/ods/dcl). For further information, please visit the Office for Disability Services website (http://equity.psu.edu/ods).

In order to receive consideration for reasonable accommodations, you must contact the appropriate disability services office at the campus where you are officially enrolled, participate in an intake interview, and provide documentation based on the documentation guidelines (http://equity.psu.edu/ods/guidelines). If the documentation supports your request for reasonable accommodations, your campus’s disability services office will provide you with an accommodation letter. Please share this letter with your instructors and discuss the accommodations with them as early in your courses as possible. You must follow this process for every semester that you request accommodations.

Attendance

This course abides by the Penn State Class Attendance Policy 42-27: http://senate.psu.edu/policies/42-00.html#42-27, Attendance Policy E-11: http://www.psu.edu/oue/aappm/E-11.html, and Conflict Exam Policy 44-35: http://www.psu.edu/ufs/policies/44-00.html#44-35. Please also see Illness Verification Policy: http://studentaffairs.psu.edu/health/welcome/illnessVerification/, and Religious Observance Policy: http://www.psu.edu/oue/aappm/R-4.html. Students who miss class for legitimate reasons will be given a reasonable opportunity to make up missed work, including exams and quizzes. Students are not required to secure the signature of medical personnel in the case of illness or injury and should use their best judgment on whether they are well enough to attend class or not; the University Health Center will not provide medical verification for minor illnesses or injuries. Other legitimate reasons for missing class include religious observance, family emergencies, and regularly scheduled
university-approved curricular or extracurricular activities. Students who encounter serious family, health, or personal situations that result in extended absences should contact the Office of Student and Family Services for help:
http://studentaffairs.psu.edu/familyservices/. Whenever possible, students participating in University-approved activities should submit to the instructor a Class Absence Form available from the Registrar's Office: http://www.registrar.psu.edu/student_forms/, at least one week prior to the activity.

Weather Delays

Campus emergencies, including weather delays, are announced on Penn State News: http:/news.psu.edu/ and communicated to cellphones, email, the Penn State Facebook page, and Twitter via PSUAlert (Sign up at: https://psualert.psu.edu/psualert/).

Disclaimer Statement

Please note that the specifics of this Course Syllabus can be changed at any time, and you will be responsible for abiding by any such changes. Changes will be posted to the course discussion forum.