Abstract
These are the lecture notes for an advanced Ph.D. level course I taught in Spring'02 at the C.N. Yang Institute for Theoretical Physics at Stony Brook. The course primarily focused on an introduction to stochastic calculus and derivative pricing with various stochastic computations recast in the language of path integral, which is used in theoretical physics, hence "Phynance". I also included several "quiz" problems (with solutions) comprised of (pre-)interview questions quantitative finance job candidates were sometimes asked back in those days. The course to a certain extent follows an excellent book "Financial Calculus: An Introduction to Derivative Pricing" by M. Baxter and A. Rennie.
Highlights
How Does “Bookie the Crookie” Make Money?When odds are quoted in the form “n − m against”, it means that the event has probability m/(n + m), and a successful bet of $m is rewarded with $n.when the odds are quoted in the form “n − m on”, it is the same as “m − n against”.Suppose we have two horses, with the true odds n − m against the first horse
While if the second horse wins, the bookmaker makes a net profit of m
Stock and bond markets as any other free market generally are expected to operate in this way – buyers drive stock prices up, while sellers drive them down. This simple principle does work in the financial markets, but what determines the supply and demand for a given financial instrument is quite nontrivial and is often times dictated by certain important details of how these markets are structured, which set the rules of the game
Summary
When odds are quoted in the form “n − m against”, it means that the event has probability m/(n + m), and a successful bet of $m is rewarded with $n (plus the stake returned). Stock and bond markets as any other free market generally are expected to operate in this way – buyers drive stock prices up, while sellers drive them down This simple principle does work in the financial markets, but what determines the supply and demand for a given financial instrument is quite nontrivial and is often times dictated by certain important details of how these markets are structured, which set the rules of the game. The board of directors, which is expected to act in the interests of at least most shareholders (after all, it was elected by the majority of shareholders’ votes), in this case is likely to decide that the corporation should buy back some of the outstanding shares in the open market, which will result in an increase in the stock price. There is a fine line between regulation and overregulation; it’s a balancing act
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