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MA5121 Paper 2021

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19 views

MA5121 Paper 2021

Uploaded by

Lahiru Kariyawasam
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 6

[MA5121]

UNIVERSITY OF MORATUWA

FACULTY OF ENGINEERING

DEPARTMENT OF MATHEMATICS

M.Sc. / POST GRADUATE DIPLOMA IN FINANCIAL MATHEMATICS (2021/22)

SEMESTER I - EXAMINATION

FINANCIAL MATHEMATICS TECHNIQUES- MA 5121

Time Allowed: 3 hours June 2022

Additional Material:
Standard Normal distribution table
Instructions to Candidates:
This paper contains 5 questions on 6 pages.
Answer ALL questions.
Each question carries equal marks.
All symbols carry their usual meaning.
This is an open book examination.
If you have a doubt as to the interpretation of the wording of a question, make sure you take your
own decision, but clearly state it, on the script.
All examinations are conducted under the rules and regulations of the University.

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[MA5121]

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[MA5121]

Question 1 [20 Marks]


(a). Using a one-step binomial model obtain an expression for the European put option.
[4 Marks]
(b). A stock price is currently $40. The risk-free interest rate is 4% per annum with continuous
compounding, the volatility is 30% per annum and the time to maturity is six months
(i). Calculate 𝑢, 𝑑 and 𝑞 for a three-step binomial tree.

(ii). What is the value of six months American put option with a strike price $42?

(iii). Would American put option be optimal to exercise early?

(iv). What is the value of a six months American call option with the same strike

price?

[12 Marks]
(c). Compute the number of shares (∆) of stock that must be purchased at each step of part (b)-
(ii).
[4 Marks]

Question 2 [20 Marks]


(a). A trader holds 200 shares of IBM stock. The trader has $10,000.00 in cash. Consider the
following two strategies that the trader can follow.
Strategy A: The trader holds the 200 shares for one year, and invests $10,000.00 cash in a
risk-free bond for an annual return of 10%.
Strategy B: The trader buys 200 put options on IBM with a strike price 𝐾 = $200 that expires
in one year. The price of each option is 𝑝 = $15.00. The trader then holds 200 IBM shares
and invests s the remaining cash in the risk-free bond for an annual return of 10%.
For what values of IBM share price 𝑆𝑇 in one year at the expiration date, does strategy B
prove to be the better one?
[06 Marks]
(b). Call options on a stock are available with strike prices of $15, $17.50, 𝑎𝑛𝑑 $20, and
expiration dates in three months. Their prices are $4, $2, and $0.5, respectively. Explain how
the options can be used to create a butterfly spread. Construct a table and a figure showing
how profit varies with stock price for the butterfly spread.

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[MA5121]

[10 Marks]

(c). Use put-call parity to show that the cost of a butterfly spread created from European puts is
identical to the cost of a butterfly spread created from European calls. (Note: 𝐾2 = (𝐾1 +
𝐾3 )/2 ).
[04 Marks]
Question 3 [20 Marks]

(a). State the Black- Scholes’ model for the stock European call option pricing with all
assumptions.
[05 marks]
(b). Consider a call option when the stock is $50, the exercise price is $52, the time to maturity
is nine months, the volatility is 20% per annum and the risk-free interest rate is 10% per
annum. Three equal dividends are expected during the life of the option with ex-dividend
dates at the end of one month, at the end of four months, and at the end of six months.
Assume the dividends are $ 1.00.
(i). Calculate the value of the European call option.
[07 marks]
(ii). Use Black’s approximation to value the American call option.
[08 Marks]
Question 4 [20 Marks]
(a). If the volatility of the stock price is 30%p. a, what is the standard deviation of the percentage
price change in one trading day if there are 252 trading days in a year?
[05 Marks]
(b). The price of gold is currently $500 per ounce. The forward price for delivery in one year is
$700. An arbitrageur can borrow money at 10% per annum. What should the arbitrageur do?
Assume that the cost of storing gold is zero.
[04 Marks]
(c). Derive the formula for minimum variance hedge ratio.
[05 Marks]

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[MA5121]

(d). The following table gives data on daily the spot price and the futures price for a certain
commodity. Use the data to calculate a minimum variance hedge ratio.

Spot Price Futures Price


50.00 55.00
50.50 55.56
51.11 56.19
50.89 56.07
50.54 55.63
51.33 56.23
51.37 56.17
51.52 56.18
52.22 56.98
51.71 56.42
51.30 55.96
[06 Marks]
Question 5 [20 Marks]
(a). Current value of the S&P 500 index is 200. An Investor uses the index to protect his portfolio
value of $2,040,000. The risk-free interest rate is 10% p.a. and the dividend yield on S&P
500 is 4% pa. The beta of the portfolio is 1.5. Assume that a futures contract on the S&P 500
with four months of maturity is used to hedge the value of the portfolio over the next three
months. One future contract is for delivery of $500 times the index.
(i). What is the investor position to protect the portfolio? (Long or short S&P 500
futures)
(ii). How many S&P500 futures contracts are long or short?
(iii). If the end of three months S&P500 index turns to be 190, then what is the value
of the portfolio plus Futures contracts?
(iv). If end of three months S&P500 index turn to be 220, then what is the value of
the portfolio plus Futures contracts?

[12 Marks]

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[MA5121]

(b). Explain behaviour of Forwards and Futures of the following features:

Features Forwards Futures


Deal is done on
Price Risk
Performance/Credit Risk
Liquidity
Terms and Conditions, contract
size
delivery date
Settle
[08 Marks]

END OF THE PAPER

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