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Assignment_9

The document outlines Assignment 9 for FINS2624: Portfolio Management, due in Week 10, consisting of multiple questions related to stock price movements, option payoffs, portfolio formation, and option pricing. It includes calculations for stock values, call option premiums, risk-neutral probabilities, and expected values under various scenarios. Additionally, it presents a practical scenario involving call options on CBA stock and optional questions on Black-Scholes pricing and put-call parity.

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9 views2 pages

Assignment_9

The document outlines Assignment 9 for FINS2624: Portfolio Management, due in Week 10, consisting of multiple questions related to stock price movements, option payoffs, portfolio formation, and option pricing. It includes calculations for stock values, call option premiums, risk-neutral probabilities, and expected values under various scenarios. Additionally, it presents a practical scenario involving call options on CBA stock and optional questions on Black-Scholes pricing and put-call parity.

Uploaded by

506986561
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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FINS2624: Portfolio Management

2023 Term 3

Assignment 9 due Week 10 Tutorial

Q1 Consider a world in which some stock, S, can either go up by 25% or down by 20% in one year and no
other outcomes are possible. The continuously compounded risk-free interest, r, is 5.5% and the current price
of the stock, S0, is $100.

1. What are the possible stock values in one year’s time, ST ?

2. What are the possible payoffs of a European call option written on stock S with a strike price, X, of
$100 and time-to-expiration of 1 year, T = 1 ?

3. Suppose you want to form a portfolio, P , consisting of short on one call option and long on some
number, ∆, of the stock, such that the portfolio value in one year’s time, PT , does not depend on the
value of the stock, ST . What would be the appropriate value of ∆, also called the hedge ratio or delta?

4. What would be the (certain) portfolio value in one year’s time, PT ?

5. What is the arbitrage-free value of the portfolio today, P0 ?

6. What is the premium of the call option today, c0 , if there is no arbitrage opportunity?

7. Define p = erT − d /(u − d), and call this the risk-neutral probability that the stock price increases.


What is the value of p ?

8. What is the expected value of the stock in one year’s time, E (ST ), under the risk-neutral probabilities?

9. At what continuous rate would the stock price have to grow to end up at the expected value?

10. What would be the expected value of the call option in one year’s time, E (cT ), under the risk-neutral
probabilities?

11. At what continuous rate would the call price have to grow to end up at the expected value?

Q2 You have purchased 10 call option contracts on CBA stock with an exercise price of $58.50. These
options were quoted at $2.50 when purchased. Each contract gives you the right to purchase 100 shares of
CBA. The option expires today when CBA stock is trading at $62.60. What is the net profit or loss on this
investment ignoring trading costs and taxes?

Q3 (Optional: Week 10’s material) You are pricing options with the following characteristics:

• Current stock price (St ): $35.60


• Exercise price (X): $50
• Time to expiration (T − t): 9 months
• Risk-free rate (rf ): 3.25%
• Volatility (σ): 45%

(a): What is the Black-Scholes value of call option? In your hand-written solution, provide the calculations
of d1 , d2 , and the final call price. Use Excel or another spreadsheet program to compute the values of N (d1 )
and N (d2 ). See the notes for details.

(b): Using put-call parity, what is the value of a put option? For this case, assume continuous compounding,
which implies that P Vt (X) = e−r(T −t) · X.

Marking: To obtain the full credit, you need to attempt all parts of all questions (except Q3).

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