University of Technology Sydney

25872 Interest Rates and Credit Risk Models

Warning: The information on this page is indicative. The subject outline for a particular session, location and mode of offering is the authoritative source of all information about the subject for that offering. Required texts, recommended texts and references in particular are likely to change. Students will be provided with a subject outline once they enrol in the subject.

Subject handbook information prior to 2020 is available in the Archives.

UTS: Science: Mathematical and Physical Sciences
Credit points: 8 cp

Subject level:

Postgraduate

Result type: Grade and marks

There are course requisites for this subject. See access conditions.

Description

This subject considers models which allow for interest rate risk and/or the possibility of credit default. The aim of this subject is for students to obtain a thorough working knowledge of models for interest rate and credit risk, their practical implementation and calibration to market data, their underlying assumptions and limitations, as well as applying the mathematical techniques underpinning the models. The subject concludes with a case study from the global financial crisis (GFC) which illustrates the ethical issues and potential conflicts of interest, as well as the modelling limitations, that can arise in the design, valuation and issuance of structured financial products.

Subject learning objectives (SLOs)

Upon successful completion of this subject students should be able to:

1. Apply and calibrate to market data standard stochastic models of interest rate and credit risk
2. Pay due regard to the limitations that a lack of data can impose on the use of such models
3. Derive closed-form and near closed-form solutions to derivative pricing problems involving interest rate and credit risk
4. Understand the ethical issues and potential conflicts of interest that can arise in the design, valuation and issuance of structured financial products

Contribution to the development of graduate attributes

This subject considers models which allow for interest rate risk and/or the possibility of credit default. The aim of this subject is for students to obtain a thorough working knowledge of models for interest rate and credit risk, their practical implementation, statistical estimation and calibration to market data, their underlying assumptions and limitations, as well as applying the mathematical techniques underpinning the models. Students will be expected to implement some models on a computer.

This subject contributes to the development of the following graduate attributes:

  • Business knowledge and concepts
  • Business practice oriented skills

This subject also contributes specifically to develop the following Program Learning Objectives for the Master of Quantitative Finance:

  • 1.1: Access and critically analyse financial data to inform and thus facilitate effective decision making
  • 5.1: Master quantitative finance technical skills necessary for professional practice

Teaching and learning strategies

The subject is presented in seminar format. Essential principles are presented and analysed in the lecture component and in addition students are lead through practical application exercises. Online delivery of subject material is seamlessly integrated with the face-to-face teaching component of the subject, and “flipped learning” permit a significant part of the contact hours to be devoted to guided computer exercises.

Content (topics)

  • Basic concepts of stochastic interest rate modelling
  • Multifactor Gauss/Markov HJM: interest rate, exchange rate and equity risk
  • The lognormal LIBOR Market Model and its extensions
  • Basic concepts of stochastic credit risk modelling
  • Black/Scholes/Merton credit risk modelling and extensions - incl. jump diffusions
  • Spread-based modelling of credit risk
  • Counterparty credit risk
  • Modelling default dependence
  • Case study: Structured credit products in the Financial Crisis

Assessment

Assessment task 1: Assignment (Individual)

Objective(s):

This assessment task addresses subject learning objective(s):

1, 2 and 3

Weight: 50%

Assessment task 2: Final Exam (Individual)

Objective(s):

This assessment task addresses subject learning objective(s):

1, 2, 3 and 4

This assessment task contributes to the development of course intended learning outcome(s):

1.2

Weight: 50%
Length:

2 hours.

Minimum requirements

Students must achieve at least 50% of the subject’s total marks.

Required texts

There is no designated textbook for this subject. Some reference books are listed below. Furthermore, at the end of each set of lecture slides, a list of recommended further reading will be provided.

References

  • Brigo, D. and F. Mercurio 2006, Interest Rate Models: Theory and Practice - With Smile, Inflation and Credit, 2nd edition, Springer Finance
  • Brace, A. 2008, Engineering BGM, Chapman Hall.
  • Bielecki, T. R. & Rutkowski, M. 2002, Credit Risk, Springer Finance.
  • Brigo, D., M. Morini and A. Pallavicini 2013, Counterparty Credit Risk, Collateral and Funding: With Pricing Cases For All Asset Classes, Wiley Finance
  • Chiarella, C., X. He and C. Sklibosios Nikitopoulos, 2015, Derivative Security Pricing: Techniques, Methods and Applications, Springer.
  • Schlögl, E., 2013, Quantitative Finance - An Object-Oriented Approach in C++, CRC Press.

Other resources

Course website

Additional materials will be provided to students in hardcopy or via the course website ( http://online.uts.edu.au). Please check the website regularly for any announcements and for additional useful links/electronic resources.

UTS resources to assist in writing assignments can be found at www.uts.edu.au/node/50946.