Faculty of Science

Undergraduate - Unit

This unit entry is for students who completed this unit in 2013 only. For students planning to study the unit, please refer to the unit indexes in the the current edition of the Handbook. If you have any queries contact the managing faculty for your course or area of study.

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6 points, SCA Band 2, 0.125 EFTSL

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FacultyFaculty of Science
Organisational UnitSchool of Mathematical Sciences
OfferedClayton First semester 2013 (Day)
Coordinator(s)Professor Fima Klebaner


Random variables, application to models of random payoffs. Conditional expectation. Normal distribution and multivariate normal distribution. Best predictors. Stochastic (random) processes. Random walk. Limit theorems. Brownian motion. Ito integral and Ito's formula. Black-Scholes, Ornstein-Uhlenbeck process and Vasicek's stochastic differential equations. Martingales. Gambler's ruin. Fundamental theorems of Mathematical Finance. Binomial and Black-Scholes models. Models for Interest Rates. Risk models in insurance. Ruin probability bound. Principles of simulation. Use of Excel package.


On completion of this unit students will be able to:

  1. Appreciate the modern approach to evaluation of uncertain future payoffs;

  1. Describe the concepts of arbitrage and fair games and their relevance to finance and insurance;

  1. Understand conditional expectation, martingales, and stopping times, as well as the Optional Stopping Theorem;

  1. Interpret models of random processes such as random walk, Brownian motion and diffusion, and stochastic differential equations;

  1. Use Ito's formula and basic stochastic calculus to solve some stochastic differential equations;

  1. Apply the Fundamental theorems of asset pricing to the Binomial and Black-Scholes models, as well as models for bonds and options on bonds;

  1. Formulate discrete time Risk Model in Insurance and use the Optional Stopping Theorem to control probabilities of ruin;

  1. Simulate stochastic processes and solutions of stochastic differential equations, and obtain prices by simulations.


Assignments: 20%
Weekly exercises: 10%
Final examination (three hours): 70%

Chief examiner(s)

Contact hours

Three 1-hour lectures and one 1-hour support class per week


One of MTH1030, MTH1035 or ETC2440 and one of MTH2010, MTH2015, MTH2032, MTH2222 or ETC2520. Either MTH2222 or ETC2520 is highly recommended.


ETC3510, ETC5351