Mathematical Finance End Sem
Mathematical Finance End Sem
MA 5950-Mathematical Finance
End Semester Exam (for Graduating Students)
08/06/2020
Time: Two Hours Maximum: 40 Marks
This question paper has 10 questions in Part-A and 4 questions in Part-B.
The Standard Normal Distribution table is attached at the end.
PART-A
(Each question carries two marks)
5. State the put-call option formula. Prove the put-call option formula
using law of one price.
1
7. Let C be the cost of a call option to purchase a security at time t for
the price K. Let S be the current price of the security, and let r be the
continuously compounded interest rate. State and prove an inequality
involving the quantities C, S, and Ke−rt .
8. In the no-arbitrage probability distribution which is a geometric Brow-
nian motion with drift parameter µ and volatility σ, show that µ =
rt − σ 2 t/2 where r is the continuously compounded interest rate.
9. Show that the no-arbitrage put option cost P (s, t, K, σ, r) of the risk-
neutral geometric Brownian motion , is decreasing and convex in s.
10. Find the no-arbitrage cost of a European (K, t) call option on a security
that at times tdi , i = 1, 2 pays f (S(tdi )) as dividends,
where td1 < td2 < t.
PART-B
(Each question carries five marks)
1. Let C(K, t) and P (K, t) be the costs of European call and put options
respectively, on a specified security that has strike price K and expira-
tion time t. For fixed expiration time t,
(a) show that C(K, t) is a convex and non-increasing function of K.
(b) prove that P (K, t) is convex in K, or explain why it is not neces-
sarily true.
2. The initial price of a stock is 100 and the price after one period is
assumed to be either 200,110 or 50. At a cost of C per share, we can
purchase at time 0 the option to buy the stock at time 1 for the price
of 150. The normal interest rate per period is r = 10%.
(a) Write down the return matrix R corresponding to investments in
one share of the stock and one call option.
(b) Find an interval for which there is no arbitrage if C lies in that
interval.
(c) Find an arbitrage strategy x such that xT R > 0 for a C not in
the no-arbitrage interval.
3. The prices of a certain security follow a geometric Brownian motion
with parameters µ = .10 and σ = .25. If the securitys price is presently
40, what is the probability that a call option, having four months until
its expiration time and with a strike price of K = 42, will be exercised?
If the interest rate is 8%, what is the risk-neutral valuation of the call
option ?
2
4. (a) Let Xi , i = 1, 2, ..., n be independent random variables, all having
the same distribution with expected value µ and variance σ 2 . Let X =
(Σn1 Xi )/n. Show that E(S 2 ) = σ 2 where S 2 = (Σn1 (Xi − X)2 )/(n − 1)
(b) Explain any one method of estimating the volatility σ of a stock
price.
***
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