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    AFE - 2nd Assessment MAMOON 25346

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    Uroona Malik
    This document contains 5 solutions to financial economics problems presented in an exam. Solution 1 calculates risk neutral probability for a call option. Solution 2 prices a put option using the put-call parity relationship. Solution 3 prices a call option using a binomial option pricing model. Solution 4 again calculates risk neutral probability, this time for a bond option. Solution 5 replicates an option payoff using a portfolio of stocks and bonds.

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    © All Rights Reserved
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    AFE - 2nd Assessment MAMOON 25346

    Uploaded by

    Uroona Malik
    31 views5 pages
    This document contains 5 solutions to financial economics problems presented in an exam. Solution 1 calculates risk neutral probability for a call option. Solution 2 prices a put option using the put-call parity relationship. Solution 3 prices a call option using a binomial option pricing model. Solution 4 again calculates risk neutral probability, this time for a bond option. Solution 5 replicates an option payoff using a portfolio of stocks and bonds.

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    AFE_2nd Assessment MAMOON 25346

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    This document contains 5 solutions to financial economics problems presented in an exam. Solution 1 calculates risk neutral probability for a call option. Solution 2 prices a put option using the put-call parity relationship. Solution 3 prices a call option using a binomial option pricing model. Solution 4 again calculates risk neutral probability, this time for a bond option. Solution 5 replicates an option payoff using a portfolio of stocks and bonds.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    31 views5 pages

    AFE - 2nd Assessment MAMOON 25346

    Uploaded by

    Uroona Malik
    This document contains 5 solutions to financial economics problems presented in an exam. Solution 1 calculates risk neutral probability for a call option. Solution 2 prices a put option using the put-call parity relationship. Solution 3 prices a call option using a binomial option pricing model. Solution 4 again calculates risk neutral probability, this time for a bond option. Solution 5 replicates an option payoff using a portfolio of stocks and bonds.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 5

    INSTITUTE OF BUSINESS MANAGEMENT

    2nd Assessment
    Course Title: Applied Financial Economics Course Code: ECO 408
    Faculty: Steve Ernest Section:-
    Day /Date: Sun/16th August 20’Start Time:-

    Student’s Name: MAMOON UR RASHEED Student ID: 20191-25346

    Note: Please attempt all questions.

    1.

    2.

    3.

    1
    4.

    5.

    Solution 1
    Risk neutral probability = p* = (e^(r-delta)*h – d) / u-d
    P* = (50e^ (0.06-d) (0.5) – 40) / 25
    For delta = 0,
    Call premium = e^-0.5(0.06) (62-62)
    Call Premium = 13e^-0.03
    P* = (50e^0.03 – 40) / 25
    P* = 0.460909

    For delta = 0.02


    P* = (50e^0.02 – 40) / 25
    P* = 0.440403

    Change in Premium = 13 e^-0.03(0.440403 – 0.460909) =


    Change in Premium = -0.2587

    2
    Solution 2
    Range = 60 – 40 = 20

    Diff in payoff = 0 – 10

    Delta = (-10 / 20) = -0.5

    60 (0.5) + e^0.05 B = 0

    -30 + e ^0.05 B = 0

    B = 30 e^-0.05

    B = 28.537=69

    Put premium =-0.5(50) +28.5369

    Premium = 3.5369

    Solution 3
    Stock can go up to = u * S = 1.2(50) = 60

    Payoff when price rises = 60 -55 = 5

    Stock can go down to = d*S = 0.7(50) = 35

    Price of call = payoff x p* e^-0.25r = 5 ((e^0.25r – 0.7) / (1.2 – 0.7)) e^-0.25r

    3.10 = 10 (1-0.7 e^-0.25r)

    0.31 = 1 – 0.7 e^-0.25r

    -0.69 = - 0.7 e^-0.25r

    - 069/-0.7 = e^-0.25 r

    0.69/0.7 = e^-0.25 r

    Ln 0.69/0.7 = ln (e^-0.25r)

    - 0.01438872295= - 0.25 r

    r = -0.014388372295 / - 0.25

    r = 0.0575549

    3
    Solution 4

    First set the lower and upper nodes.

    U = e^(r-δ) + δ = e^0.05-0.02+0.3 = e^0.33

    d = e^(r-δ) -δ = e^0.05-0.02-0.3 = e^0.27

    0.03 −0.27
    e(r−δ )−D e −e
    For P* = = 0.33 0.27
    U −d e −e

    1.030455−0.763379
    P* =
    1.390968−0.763379

    P* = 0.42556

    Solution 5

    Assume ∆q be the no of shares of Q for replicating portfolio.

    And ∆s be the number of shares of S for replicating portfolio.

    And suppose B the amount invested in a risk free Bond.

    Payoff of the portfolio from top to bottom are 40, 50 and 110.

    Then,

    90∆s + 30∆q + Be^0.05 = 40

    90∆s + 100∆q + Be^0.05 = 50

    200∆q + Be^0.05 = 110

    Use substitute method:

    Subtract the second equation from the 1st,

    90∆s + 100∆q + Be^0.05 = 50

    -90∆s - 30∆q - Be^0.05 = -40

    70∆q= 10________________

    4
    ∆q= 1/7

    Then find the value of be^0.05 from 3rd equation:

    200∆q + Be^0.05 = 110

    200
    Be^0.05 = 110 -
    7

    Put both values into 1st equation:

    30
    40− −81.486
    ∆s = 7 = -0.5079
    90

    The option portfolio worth is;

    50 (-0.5079) + 100/7 +81.4286e^-0.05 = 66.35

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