Take Home Assignment and Extra Credit Video II:

“NOVA: Trillion Dollar Bet” (aka: “BBC: The Midas Formula”) 

(A separate link to the video is posted on Isidore) 

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

Although B-S was originally developed for pricing stock options, the formula that we have been using in class for currency options is virtually identical. Specifically, except 

for the e−r*T term that discounts by the foreign interest rate, and of course the fact that the underlying asset is a foreign currency rather than a share of stock, the formulas are exactly the same. 

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. forecasting 

• –  Statistical methods for characterizing returns and measuring risk 

• –  Risk transfer role of derivatives and hedging 

• –  Derivatives trading and exchanges 

• –  International capital flows and investment 

• –  Currency crisis and contagion 

  Besides these, the video also gives a great glimpse into the world of academic finance, the inner workings of financial markets and institutions, and the nature of financial crises. While you are watching, 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.). 

  Extra Credit Assignment Value: +20 points. 

  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 single spaced for he entire assignment