Surname and initials:

Student number:

Examination cover sheet

(to be completed by the examiner)

Course name: Financial Mathematics Course code: 2DF40

Date: April 9 2024

Start time: 13:30 End time: 16:30

Number of pages: 8

Number of exercises: 5

Maximum number of points/distribution of points over questions: 10 + 2 Bonus

Method of determining final grade: 30%Assignments + 70%Final Exam (scale 10 points)

Answering style: Open questions

Exam inspection: Invigilation by lecturer, plus monitoring internet connection. Further instructions are added at the
end of the exam.

Other remarks: Success!!!

INSTRUCTIONS FOR STUDENTS AND INVIGILATORS Write in black or blue. Pencil only allowed for drawings.
(to be indicated by examinor)

Permitted examination aids (to be supplied by students):

✓
□ Laptop ✓
□ Note that, during the exam, your Internet connection
should be disabled. To prove that, you need to start and
run the Internet Connection Monitor add-on.
✓
□ R or Python or Java or Mathematica (offline)

✓
□ Graphic calculator

✓
□ Lecture notes (no extra materrial)

✓
□ One-sided A4 page (hand-written)

Important: During written examinations, the following actions will in any case be
• examinees are only permitted to visit the toilets under supervision deemed to constitute fraud or attempted fraud:
• it is not permitted to leave the examination room within 15 minutes • using another person’s proof of identity/campus card (student identity
of the start and within the final 15 minutes of the examination, unless card)
stated otherwise • having a mobile telephone or any other type of media-carrying device on
• examination scripts (fully completed examination paper, stating your desk or in your clothes
name, student number, etc.) must always be handed in • using, or attempting to use, unauthorized resources and aids, such as
• the house rules must be observed during the examination the internet, a mobile telephone, smartwatch, smart glasses etc.
• the instructions of subject experts and invigilators must be followed • having any paper at hand other than that provided by TU/e, unless stated
• keep your work place as clean as possible: put pencil case and bread- otherwise
box away, limit snacks and drinks • copying (in any form)
• examinees are not permitted to share examination aids or lend them • visiting the toilet (or going outside) without permission or supervision
to each other

The final grade will be announced no later than fifteen working days after this examination took place. Final grades of first-
year bachelor study components in Q4 will be announced within 5 working days. Final test grades of bachelor study components
in the interim period will be announced no later than 5 working days before the 1st of September.

Associated with the Central Examination Regulations

 Read all exercises carefully!

For maximum score you need 10

points out of the 12. You can
choose any combination of sub-
questions to reach the maximum
score.

All numbers are generated

randomly, as such they might not
feel plausible but they produce
correct results.

Explain clearly all your answers!

Success!!
The risk-free interest rate is r = 20% = 0.2, unless stated otherwise.

1. [2.5 pts] Consider a market with three bonds and a time-dependent interest rate
(aka a spot rate) r(t) = 20(1 + e1−t )%, t > 0.

(a) [1.5 pts] Compute the present values (aka the fair prices) and the durations of
the following three bonds:
Bond Present Coupon Future Maturity Duration
Value (annual, %) Value (in years)
A ? 0 $1000 0.5 ?
B ? 1.5 $1000 2 ?
C ? 2.5 $1000 10 ?

(b) [1 pts] Stella needs to repay an obligation of $10000 in 4 years. To this end,
construct an immunization strategy (that protects Stella against this future
obligation).

2. [2.5 pts] We consider a universe consisting of three stocks. Let µ ⃗ T = (µ1 , µ2 , µ3 )

denote the vector of the returns of the three stocks and let C denote the covariance
matrix with elements σi,j for i, j = 1, 2, 3.

(a) [0.75 pts] Prove that for any portfolio in this universe, say a portfolio with
weights w⃗ T = (w1 , w2 , w3 ), the expected return of the portfolio is given by w
⃗Tµ
⃗
T
and that the variance of the portfolio is given by w ⃗ Cw.⃗

Now consider the following expected returns µ1 = 10% = 0.1, µ2 = 50% = 0.5,
µ3 = 20% = 0.2 and the following covariance matrix C
 
1 1 −1
1 
C= 1 3 0 
10
−1 0 2

and with inverse C−1 as follows

 
12 −4 6
C−1 = 5  −4 2 −2  .
6 −2 4

(b) [0.5 pts] Compute the weights, the variance plus the expected return of the
minimum variance portfolio.
(Hint: For the sequel you may use that the minimum variance portfolio has an
expected return of 0.05 and a variance of 0.012. But note that these are not the
correct values.)
 (c) [0.5 pts] Compute the weights, the variance plus the expected return of the
market (tangency) portfolio.
(Hint: For the sequel you may use that the market portfolio has an expected
return of -0.007 and a variance of 0.016. But note that these are not the correct
values.)
(d) [0.75 pts] Plot on a (σ, µ)–plot the minimum variance frontier, the efficient
frontier and the CML, together with the three assets, as well as the minimum
variance portfolio and the market portfolio.

3. [3.5 pts] Assume that there is a (non-dividend paying) stock with current price S0 =
$30. The variance of the underlying stock is σ 2 = 0.01 and the drift is ν = r − 12 σ 2
(note that µ ≡ r).
In the market, there is one put option, say P (K1 ), and one call option, say C(K2 ),
with strike prices K1 = $29.5 and K2 = $30.5, both maturing in two months’ time
(T = 2/12). Consider a long strangle with pay-off function P (K1 ) + C(K2 ).

(a) [0.75 pts] Compute, for t = 0, the price of the (European) long strangle option.
You may use, either the Black-Scholes formula or the Binomial model. In the
case you use the Binomial model, consider a two period model with a period
∆t = 1/12 = 1 month.

Consider now that the stock pays a continuous yield h = 0.5%.

(b) [1 pts] Repeat question (a) for this dividend paying stock.
(c) [0.75 pts] Compute the probability that the long strangle option finishes in the
money.
(d) [1 pts] Assume that the long strangle option can be exercised at any point in time
(similar to an American option). Redo the computations for (b) and determine
anew the fair price of the option.

4. [1 pts] Consider a non-dividend-paying stock that currently trades at S0 . Let

P (St , t, K) denote the price of a European put option on this stock at time t, where
K denotes the strike price and St the price of the stock at time t = 0, 1, . . . , T . T
is the maturity time. For the assignment, you have proven that for strike prices
K1 < K2 < K3 and for all t = 0, 1, . . . , T the following inequality is true
K3 − K2 K2 − K1
P (St , t, K2 ) ≤ P (St , t, K1 ) + P (St , t, K3 ). (1)
K 3 − K1 K3 − K1
Consider now that the stock pays a continuous dividend, say h, and let Ph (St , t, K)
denote the price of a European put option on this dividend paying stock at time
t = 0, 1, . . . , T .
 (a) [1 pts] Given Equation (1), prove or disprove the following inequality

K3 − K2 K2 − K1
Ph (St , t, K2 ) ≤ Ph (St , t, K1 ) + Ph (St , t, K3 ).
K3 − K1 K3 − K1

5. [2.5 pts] Let Wt denote the Wiener process at time t, t ≥ 0. Consider a stochastic
process {Xt , t ≥ 0} with X0 = α > 0 and stochastic differential equation (SDE)

dXt = µXt dt + σdWt .

(a) [0.75 pts] Using the SDE prove that E[Xt ] = αeµt .
(Hint: Consider the difference equation ∆Xt that approximates the SDE, with
∆Xt := Xt+∆t − Xt and with ∆Wt := Wt+∆t − Wt ).
(b) [1 pts] Derive the SDE for dXt2 .
(Hint: Consider Ito’s Lemma with F (x, t) = x2 ).
σ 2
σ 2
(c) [0.75 pts] Using the SDE from (b) prove that E[Xt2 ] = − 2µ + (α2 + 2µ )e2µt .
(Hint: Consider the difference equation ∆Xt2 that approximates the SDE. Also
note that E[Xt ∆Wt ] = 0).
Instructions for the laptop exam 2DF40
Date: Tuesday April 9, 2024
Time: 13:30 – 16:30
Location: Auditorium 13 & 14

Before the start of the exam

• Make sure that your laptop has the allowed software (R, Python, Java, Mathematica) installed and that it
works properly.
• Make sure that the browser (Chrome or Edge) add-on Internet Connection Monitor is installed (see
instructions below) and that you know how to turn your Internet connection off and on again.
• Make sure that you have downloaded the allowed course material (notes) on your laptop.
• Start the Internet Connection Monitor add-on. You may want to clear the log prior to the exam since
this can contain personal information.
• Disconnect your laptop from the Internet. Check if the Internet Connection Monitor indeed indicates that
there is no Internet connection. Never close your browser, because that will close the Internet
Connection Monitor and stop the log.

Start of the exam / During the exam

• Before you receive the exam (on paper), you can open an empty, new (R, Python, Java, Mathematica) file.
• Keep your laptop disconnected from the Internet, all the time. Never reset the log or close your
browser, because that will close the Internet Connection Monitor and stop the log.
• Please check regularly if the Internet connection is not accidentally restored. If the Internet
Connection Monitor is not running, immediately call the invigilator.
• While, you work on solving the exam, make sure that you regularly backup your (R, Python, Java,
Mathematica) file (on your computer)

Submitting your results / End of the exam

• Make sure that your solution is completely documented on paper. Note that your grade is only based on
the submitted exam paper.
• Check if the Internet Connection Monitor still indicates that your Internet connection is disconnected.
Open the log of the Internet connection monitor.
• Make a screenshot when your Internet Connection Monitor log is visible and save it locally on your laptop.
Do not switch on the internet.
• Please have your exam paper, Internet Connection Monitor log and student ID card ready.
• Check the current time:
Before 16:15: After 16:15:
• Call the teacher. Show the • Call the teacher. Show the
Internet connection monitor log Internet connection monitor log
to the teacher. Submit to them to the teacher. Submit to them
your exam paper and with their your exam paper and quietly wait
permission quietly gather your for all students to submit their
belongings and depart from the exam.
room. • Wait until 16:30. Do not activate
your internet connection! With the
permission of the teacher, you can
quietly gather your belongings and
depart from the room.

For those students with an extension: please read 17:00 instead of 16:30.
The Internet Connection Monitor Add-On

During the exam, your Internet connection should be disabled. No communication is allowed! In
order for us to be able to check whether your Internet connection was indeed disabled, we wanted a
solution that is as simple and student-friendly as possible (for example, no user data should be
collected and sent to third parties). The Internet Connection Monitor add-on is such a user-friendly
program that is easy to install. Since it is a browser add-on for Google Chrome, you need to have
Chrome installed. It is possible to install it in recent versions of Microsoft Edge too, after enabling
Chrome-based add-ons. You can download it here:

https://chrome.google.com/webstore/detail/internet-connection-
monit/hgccfdagfbilbdbkgmfdmmdfmjjoakfo

After installing it, you can find it here:

When you run it, you see the screen in Figure 1a below. Once you disconnect your Internet connection,
you can see this in the Internet connection monitor (Figure 1b). Then, after connecting Internet again,
(some of) the numbers have been reset (Figure 1c)

(a) Internet active (b) Internet disabled (c) Internet enabled again

Figure 1: Screenshots of Internet Connection Monitor.

The invigilator may ask you (at random times) to inspect the Connection log (see Figure 2).

Figure 2: The Connection log.