Module Directory

This module involves around the theoretical foundations of some widely used pricing models for securities traded in financial markets, i.e. equities, options and bonds. For equities, models such as the Gordon growth model, the Classical CAPM, and the APT are frequently used by applied researchers and by practitioners. Similarly, the Black-Scholes formula, along with CRR (Cox-Ross-Rubinstein) binomial model, is often utilized in option pricing in practice.

While such applied works take the end product (the model) for granted as a black box, this module is aimed at explaining the theoretical foundations of these models from a unified viewpoint so that the students should be able to appreciate the usefulness and/or the weakness of these models after taking the module.

The aim of this module is:

• To provide a rigorous treatment of asset pricing literature including CAPM, and the fundamental theorem of asset pricing and its applications in pricing contingent claims.

By the end of this module, students will be expected to be able to:

1. Understand the economic concepts associated with the fundamental theorem of asset pricing and to appreciate its usefulness to finance.


2. Understand the mathematics associated with the mean-variance analysis and portfolio choices by rational investors.


3. Understand the mechanism of different types of derivatives and to price them, and to be able to establish the relationship between the price of primary securities and those of derivative securities.

Skills for Your Professional Life (Transferable Skills) 

1. By studying the theoretical foundations of pricing models students will be able to understand the assumptions used by these models and critically analyse them.


2. Appreciate the usefulness and/or the weaknesses of these models, and to understand why sometimes they work/fail in practice. This type of knowledge is particularly useful in areas such as investment banking and asset management.

The module is designed for third year finance students. It may have appeal to accounting and management students possessing a technical bent, to similarly inclined economics students with an interest in financial economics, and to mathematics students interested in financial markets.

The primary focus of the module is on the development of problem-solving skills. Students are encouraged to work on the problems discussed in the lectures – otherwise it may be difficult for them to understand the general principles of asset pricing (simply memorising the end results does not provide an understanding of the general principles from which those results are derived). By working on concrete problems students are more likely to be able to understand the general principles.

Class exercises will be announced in advance and, in principle, students may be appointed on site to work on the questions on the whiteboard in the classes. Hence, students are expected to work on all exercises in advance.