CT8 Financial Economics An Introduction brief

Are you planning to appear for CT8 this diet and not sure about the course? Don’t worry here is the brief introduction to CT8 Financial Economics which helps you to grasp a brief understanding of the subject so that you can take your decision with no more confusion in your mind.

Before that let us understand what is the aim of the course. So, the aim of the Financial Economics subject is to develop the necessary skills to construct asset liability models and to value financial derivatives. These skills are also required to communicate with other financial professionals and to critically evaluate modern financial theories.

Financial economics as presented in this course involves the modeling of financial markets. The choice and accuracy of the model chosen are critically dependent on the efficiency of the market – i.e. whether market prices quickly and accurately reflect all available information.

Brief Introduction of what is going to be cover in CT8

  • Understanding of term “utility function”, the axioms underlying utility theory and the expected utility theorem, the economic properties of commonly used utility functions.
  • How a utility function may depend on current wealth and discuss state-dependent utility functions, the concept of utility maximization and hence explain the traditional theory of consumer choice.
  • Conditions for absolute dominance and for first and second-order dominance and discuss their relationship with utility theory.
  • Measures of investment risk: variance of return, downside semi-variance of return, shortfall probabilities, Value at Risk (VaR) / Tail VaR, the advantages and disadvantages of different measures of investment risk.
  • The assumptions of mean-variance portfolio theory and the conditions under which application of mean-variance portfolio theory leads to the selection of an optimum portfolio, the benefits of diversification using mean-variance portfolio theory.
  • Three types of multifactor models of asset returns: macroeconomic models, fundamental factor models, statistical factor models. Discuss the single index model of asset returns. Perform calculations using both single and multi-factor models.
  • The assumptions and the principal results of the Capital Asset Pricing Model (CAPM), the limitations of the basic CAPM, the assumptions, principal results and limitations of the Arbitrage Pricing Theory model (APT).
  • Three forms of the Efficient Markets Hypothesis and their consequences for investment management. Describe briefly the evidence for or against each form of the Efficient Markets Hypothesis. Discuss the main issues involved in estimating parameters for asset pricing models.
  • A knowledge and understanding of stochastic models of the behavior of security prices.
  • The main concepts of Brownian motion (or Wiener Processes), a basic understanding of stochastic differential equations, the Ito integral, diffusion and mean-reverting processes, understanding of options prices, the factors that affect option prices.
  • How to value a forward contract.
  • Upper and lower bounds for the European and American call and put options.
  • Put-call parity, how to use binomial trees and lattices in valuing options and solve simple examples, explain the difference between the real-world measure and the risk-neutral measure.
  • Black-Scholes model in valuing options and solve simple examples, the validity of the assumptions underlying the Black-Scholes model.
  • Vasicek, Cox-Ingersoll-Ross and Hull-White models for the term structure of interest rates.
  • The different approaches to modeling credit risk: structural models, reduced form models, intensity-based models. Understanding the Merton model.
  • Understanding of a two-state model for credit ratings with a constant transition intensity, how the two-state model can be generalized to the Jarrow-Lando-Turnbull model for credit ratings.

Some common questions that students have regarding CT5 are covered below:

Q. What is CT8 as per 2019 Curriculum?
Ans. Under the 2019 Curriculum, CT8 has been renamed as CM2 (Core Mathematics 2). This exam will consist of two elements. One will be 3 hours 15 minutes written exam, and the other will be 1 hour 45 minutes of the practical exam using MS Excel. Both elements need to be taken at the same examination sitting.

Q. Which topics should be focused on for scoring good marks?
Ans. There are some topics like Mean-Variance Portfolio Theory, Capital Asset price model(CAPM), Binomial Model, Black Scholes, Credit Risk which is quite scoring in the CT8 exam. However, all chapters are equally important and you should not skip anything and should be familiar with all the concepts given in the subject.

Q. What knowledge of earlier subjects should I have?
Ans. Most students find CT8 quite a tough course compared to some of the other CT subjects and so a good grasp of the material in the earlier subjects, especially Subjects CT1, CT3, and CT6 is essential. Some of the material in CT2, CT4, and CT7 are also relevant.

Q. Which subjects would require the knowledge of CT8?
Ans. Subjects CA-1 (Actuarial Risk Management), ST-6 (Finance and Investment Specialist Technical B.) and ST-9 (Enterprise Risk Management) use the principles introduced in CT-8.

So, to clear CT8 you have to put in a lot of efforts besides being deterministic and self-motivated. I will advise you to take membership from both IAI and IFOA and give the exam from both institutes for the same diet.

To know more on how to prepare for actuarial science exams, click here.

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