ex1 The correct answer is C.
See the slide from week 1 titled "Valuation of uncertain cash flows (2/2)"
ex2 To avoid arbitrage, the expected return on a bond priced with the spot rates bought at 0 and sold at 5 must be equ
The correct answer is B
ex3 If the forward rate from T to T+K is lower than its correct value, this means that the forward contract will pay at T+
As a cnsequence, there is the following arbitrage strategy: Sell the forward contract, borrow the present value of 1
The correct answer is A
ex4 When interest rates decrease bond prices increase. None among A,B, C is correct
The correct answer is D
ex5 If the YTM (which corresponds to a flat curve of spot rates) is equal to the coupon rate, the price of the bond is its f
The correct answers is C
Price of Bond at t=0 1000
ex6 When the maturity of a bond is higher, the duration is higher. When the yield to maturity of a bond is lower, its du
The correct answer is B
At lower yields the more distant coupon payments made by the bond have relatively greater present values and ac
Thus in the weighted-average calculation of duration, the distant payments receive greater weights, which results i
ex7 A, B and C are all correct. See the slide titled "Factors affecting option prices"
The correct answer is D Given the text of the question asks for picking the wrong one, we also accept is someone
ex8 The time value of a call option at time t is equal to the price of the call option at time t minus the intrinsic value at ti
The correct answer is D
ex9 stock price 90.0000
rf annual continuous 7.00%
A.
8-month volatility 8.16%
annual volatility 10.00%
8-month risk free 4.67%
American Call
Strike 88
r 5%
S0 90 Su
Pu - Euro
Pu - US
deltau
Bu
S0 90.0000
P0 10.3899
P0 - US 10.3899
delta0 0.8289
B0 -64.2112
Sd
Pd - Euro
Pd - US
deltad
Bd
The correct answer is D. Delta_u is qual to 1 so A, B, C are wrong
ex10 stock price 100.0000
rf annual continuous 7.00%
A.
8-month volatility 5.72%
annual volatility 7.00%
8-month risk free 4.67%
American Call
Strike 99
r 5%
S0 90 Su
Pu - Euro
Pu - US
deltau
Bu
S0 90.0000
P0 1.4117
P0 - US 1.4117
delta0 0.1591
B0 -12.9038
Sd
Pd - Euro
Pd - US
deltad
Bd
The correct answer is C, with a call option on a stock not paying dividends, there is no early exercise
in cash flows (2/2)"
ought at 0 and sold at 5 must be equal to (1+ r_0->5)^5
at the forward contract will pay at T+K less than it should.
ntract, borrow the present value of 1$ until time T and invest it until time T+K
pon rate, the price of the bond is its face value
to maturity of a bond is lower, its duration is higher. When the coupon increases, duration decreases
atively greater present values and account for a greater share of the bond's total value.
ceive greater weights, which results in a higher duration measure.
rong one, we also accept is someone did not tick any of the answers
at time t minus the intrinsic value at time T
l
Suu 105.9650
Puu 17.9650
97.6568
13.6691
13.6691
1.0000
-83.9877
Sud=Sdu 90.0000
Pud=Pdu 2.0000
82.9435
1.4733
1.4733
0.1475
-10.7606
Sdd 76.4403
Pdd 0.0000
l
Suu 100.8989
Puu 1.8989
95.2938
1.6373
1.6373
0.1742
-14.9657
Sud=Sdu 90.0000
Pud=Pdu 0.0000
85.0003
0.0000
0.0000
0.0000
0.0000
Sdd 80.2784
Pdd 0.0000
re is no early exercise
Change in rates 2.5% Year CF
Coupon rate 7% 1 70
Maturity 3y 2 70
Face value 1000 3 1070
Interest rate 8% Total
Convexity
Year CF
1 70
2 70
3 1070
Total
price today before change in interest rates 974.22903
exact new price 913.7207 Year CF
1 70
2 70
1st order approx of %price change -6.5% 3 1070
1st order approx 910.9641
1st order approx error 2.76
1st order approx error in % of price 0.3017%
2nd order approx of %price change -6.2%
2nd order approximation 913.8262
2nd order approx error 0.10549
2nd order approx error in % of price 0.0115%
PV of CF Weight Weight*Years
64.8148 0.0665 0.0665
60.0137 0.0616 0.1232
849.4005 0.8719 2.6156
974.2290 1.0000 2.8053
Convexity Duration
PV of CF PV of CF *(t+t^2)
64.8148 129.6296
60.0137 360.0823
849.4005 10192.8060
974.2290 9.4008
convexity
PV of CF with new rate
63.3484
57.3289
793.0434
913.7207
exact new price!
stock price 800
rf annual continuous 3.00%
div 1 month 0
A.
4.5-months volatility 18.37%
annual volatility 30.00%
4.5-months risk free 1.13%
D.
European CALL
strike 795.00
Su
Su excl div
Cu_EU
deltau
Bu
S0 800.00
C0_EU 85.23
delta0_EU 0.58
B0_EU -382.53 Sd
Sd excl div
Cd_EU
deltad
Bd
The american call price is higher than the Europan, as it is optimal to exercise early at time 1, hence the flexibility of the Ameri
The price of the put can be found with put call parity 62.5374592674234
One could also find it (with much longer calculations, with another binomial model
EUROPEAN PUT
strike 795.00
Su
Su excl div
pu_EU
deltau
Bu
S0 800.00
p0_EU 62.53745927
delta0_EU -0.42
B0_EU 394.78 Sd
Sd excl div
pd_EU
deltad
Bd
Straddle: long put and call wit same strike
Payoff at maturity Profit at Maturity
15 -132.76
Suu 1155.21
Cuu 360.21
961.34
961.34
175.23
1.00 S_ud 800.00
-786.11 C_ud 5.00
665.74 S_du 800.00
665.74 C_du 5.00
2.40
0.02
-11.14 S_dd 554.01
C_dd 0.00
e flexibility of the American option has value!
Suu 1155.21
puu 0.00
961.34
961.34
0.00
0.00 S_ud 800.00
0.00 p_ud 0.00
665.74 S_du 800.00
665.74 p_du 0.00
122.76
-0.98
774.97
S_dd 554.01
p_dd 240.99
See Slide from week 1 "Key Economic Roles of Financial Markets"
List Brief Description (no need to write a lot!)
1 Consumption Timing Markets allow investors to store their money in financial ass
2 Risk Sharing and Allocation Markets allow investors to hold diversified portfolios. The va
3 Information Production When news arrive, investors incorporate them in asset price
4 Separation of Ownership and Mangement Financial markets allow, through the asset that are tradedm
e their money in financial assets and trade off current consumption with future consumption
diversified portfolios. The variety of financial assets allows investors to hold portfolios with different risk profiles
corporate them in asset prices by trading. The changes in prices ultimately affect the activity of companies that issued the traded assets.
h the asset that are tradedm to separate ownwership of a company securities from the management of a company itself. This is importan
hat issued the traded assets.
ompany itself. This is important to avoid agency and asymmetric information problems when companies get too large.
1st point The price of an American Option is higher or equal to the price of an European option. This is due to the fact that th
2nd point In general it is optimal to exercise an American option when the time value turns negative. If the time value is nega
3rd point It is never optimal to exercise early an American call option on a stock without dividends. Holding on to the call allo
4th point It can be optimal to exercise an American call option on a stock with dividend payments before the dividend is paid
-
an European option. This is due to the fact that the American option provides additional flexibility to the option holder, and such flexibilit
time value turns negative. If the time value is negative, it means that the benefit of waiting before exercising the option is lower than the a
stock without dividends. Holding on to the call allows you to pay K later and gives downside protection like a put, because when S_t falls b
with dividend payments before the dividend is paid, if the time value os negative. The dividend payment will automtically decrease the stoc
older, and such flexibilityis valuable (and hence incorporated in the price)
ption is lower than the amount of money the holder could get by exercising now (intrinsic value).
because when S_t falls below K you won’t exercise and the minimum payoff is zero.
mtically decrease the stock price hurting the call option holder. If the dividend payment is large enough, the time value of the call might tur
time value of the call might turn negative.