Last Revised: 04/25/2024

2025 Level 1 - Seminars

Seminars Page
Bayes’ Formula 2

Variances and Covariances in percent squared or decimals 3

Central Limit Theorem - Standard Errors vs. Standard Deviation 4

Testing Means versus Testing Variances 8

CML vs. SML 11

DTA and DTL 14

Full and Flat Prices and Matrix Pricing 21

Why use Full Price when calculating ApproxModDur? 23

Duration and Convexity 24

Why are ModDur and EffDur different for the same bond? 28

Pricing and Valuation of Forwards and Futures 29

Options Strategies 34

Put-Call parity with Replication and Hedging 38

Why do we multiply sd by the square root of T 39

M.M151573199.

This document should be used in conjunction with the corresponding seminars in the 2025 Level 1 CFA® Program curriculum.
Some of the graphs, charts, tables, examples, and figures are copyright 2024, CFA Institute. Reproduced and republished with
permission from CFA Institute. All rights reserved.

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Institute.

2533695 Ontario Limited d/b/a MarkMeldrum.com. All rights reserved.

1
 Last Revised: 04/25/2024

Bayes’ Formula

Blue Balls Red Balls

60 40 = 100 balls

I have 6 Blue Balls

∴ I have 𝟔#𝟔𝟎 = 10% of the blue balls
but only 6% of the balls

P(up|exp.) P(up)
P(exp.|up)
.8 = .7(.8)
up . 𝟕(. 𝟖)
Expansion +
. 𝟔𝟐
.7 down
.2
.3(.2) = .56 + .06 = .9032
.2 = .62
.3 up 90.32%
down
Recession .8

P(up) P(exp.|up)
.8
Expansion up = .7(.8) 90.32% . 𝟕(. 𝟖) . 𝟓𝟔
= #. 𝟔𝟐
.7 down . 𝟔𝟐
.2 +
= 90.32%
.3(.2) 9.68%
.2
.3 up = .56 + .06 = .62_ 100%
. 𝟎𝟔#
down . 𝟔𝟐
Recession .8

𝐏(𝐈𝐧𝐟𝐨𝐫𝐦𝐚𝐭𝐢𝐨𝐧|𝐄𝐯𝐞𝐧𝐭)
𝐏(𝐄𝐯𝐞𝐧𝐭|𝐈𝐧𝐟𝐨𝐫𝐦𝐚𝐭𝐢𝐨𝐧) = M.M151573199.
𝐏(𝐄𝐯𝐞𝐧𝐭)
𝐏(𝐈𝐧𝐟𝐨𝐫𝐦𝐚𝐭𝐢𝐨𝐧)

.𝟖 . 𝟕(. 𝟖) . 𝟓𝟔
= 𝐱 (. 𝟕) = = #. 𝟔𝟐
. 𝟔𝟐 . 𝟔𝟐

2
 Last Revised: 04/25/2024

Variances and Covariances in percent squared or decimals

400 45 189 ➞ in %2 ➞ 100 × 100 = 10,000

45 81 38
189 38 441
√𝟒𝟎𝟎 = 𝟐𝟎%
covariances variances
√. 𝟎𝟒 =. 𝟐𝟎

𝟒𝟎𝟎 𝟒𝟓 𝟏𝟖𝟗
𝟏𝟎, 𝟎𝟎𝟎 𝟏𝟎, 𝟎𝟎𝟎 𝟏𝟎, 𝟎𝟎𝟎

𝟒𝟓 .04 .0045 .0189

𝟖𝟏 𝟑𝟖
𝟏𝟎, 𝟎𝟎𝟎 𝟏𝟎, 𝟎𝟎𝟎 𝟏𝟎, 𝟎𝟎𝟎 .0045 .0081 .0038
⇒

𝟏𝟖𝟗 𝟑𝟖 𝟒𝟒𝟏 .0189 .0038 .0441

𝟏𝟎, 𝟎𝟎𝟎 𝟏𝟎, 𝟎𝟎𝟎 𝟏𝟎, 𝟎𝟎𝟎 covariances variances

1 2 3
𝛔𝟐𝐩 = . 𝟓𝟎𝟐 (𝟒𝟎𝟎) + . 𝟐𝟓𝟐 (𝟖𝟏) + . 𝟐𝟓𝟐 (𝟒𝟒𝟏)
1 400 45 189
2 45 81 38 + 𝟐(. 𝟓𝟎)(. 𝟐𝟓)(𝟒𝟓) + 𝟐(. 𝟓𝟎)(. 𝟐𝟓)(𝟏𝟖𝟗)
3 189 38 441 + 𝟐(. 𝟐𝟓)(. 𝟐𝟓)(𝟑𝟖)
𝐰𝟏 = . 𝟓𝟎 𝐰𝟐 = . 𝟐𝟓 𝐰𝟑 = . 𝟐𝟓 = 𝟏𝟎𝟎 + 𝟓. 𝟎𝟔𝟐𝟓 + 𝟐𝟕. 𝟓𝟔𝟐𝟓 + 𝟏𝟏. 𝟐𝟓 + 𝟒𝟕. 𝟐𝟓
(% )2
+ 𝟒. 𝟕𝟓 = 𝟏𝟗𝟓. 𝟖𝟕𝟓 (%2) 𝟏𝟗𝟓. 𝟖𝟕𝟓
(100) 𝟏𝟎, 𝟎𝟎𝟎
𝛔 = √𝟏𝟗𝟓. 𝟖𝟕𝟓 = 𝟏𝟒%

.04 .0045 .0189 𝛔𝟐𝐩 = . 𝟓𝟎𝟐 (. 𝟎𝟒) + . 𝟐𝟓𝟐 (. 𝟎𝟎𝟖𝟏) + . 𝟐𝟓𝟐 (. 𝟎𝟒𝟒𝟏)
.0045 .0081 .0038 + 𝟐(. 𝟓𝟎)(. 𝟐𝟓)(. 𝟎𝟎𝟒𝟓) + 𝟐(. 𝟓𝟎)(. 𝟐𝟓)(. 𝟎𝟏𝟖𝟗)
.0189 .0038 .0441 + 𝟐(. 𝟐𝟓)(. 𝟐𝟓)(. 𝟎𝟎𝟑𝟖)

= . 𝟎𝟏 + . 𝟎𝟎𝟎𝟓𝟎𝟔𝟐𝟓 + . 𝟎𝟎𝟐𝟕𝟓𝟔𝟐𝟓 + . 𝟎𝟎𝟏𝟏𝟐𝟓

M.M151573199.

+ . 𝟎𝟎𝟒𝟕𝟐𝟓 + . 𝟎𝟎𝟎𝟒𝟕𝟓 = . 𝟎𝟏𝟗𝟓𝟖𝟕𝟓

𝛔 = √. 𝟎𝟏𝟗𝟓𝟖𝟕𝟓 = . 𝟏𝟒 14%

3
 Last Revised: 04/25/2024

Central Limit Theorem -

Standard Errors vs. Standard Deviation

➞ unknown distribution

sample n = 50 𝐱H = 100 s = 33
𝐇𝟎 : 𝛍 = 𝟕𝟓 how do we test the mean?
𝛍 = 𝟕𝟓 𝐇𝐚 : 𝛍 ≠ 𝟕𝟓 - can’t use z/t values

rely on a normal
distribution

Population

➞ unknown distribution

sample1 n = 50 𝐱H = 100 s = 33
sample2 n = 50 (𝐱H 𝟐 , 𝒔𝟐 )

sample3 n = 50 (𝐱H 𝟑 , 𝒔𝟑 )
sample4 n = 50 (𝐱H 𝟒 , 𝒔𝟒 )
sample5 n = 50 (𝐱H 𝟓 , 𝒔𝟓 ) 0
…

samplen n = 50 (𝐱H 𝒏 , 𝒔𝒏 )
0
M.M151573199.

100
x
x x
x x x x x
x x x x x x
x x x x x x x
Population
-

-
-

𝐱H
𝐱H

4
 Last Revised: 04/25/2024

O𝟒
𝐗
x x x O𝟗
𝐗
O 𝟓𝟑
𝐗
x x x x
x x x
x x O 𝟐𝟔
𝐗
x x x
x x x x x x x x
-

-
the mean of this distribution is the mean of
all the sample means 𝐗Q 𝐱/

· But what is the s.d.?

O𝐢 − 𝐗
∑𝐧𝐢1𝟏(𝐗 O 𝐱/ )𝟐 𝑺𝟐
𝐕𝐚𝐫 =
𝐧−𝟏 𝐧

𝐬. 𝐝. = 𝐬#
√𝐧

x x x 33
x x x x 𝟑𝟑
x x 50 ⎛ #√𝟓𝟎⎞
x x ⎜ √𝟓𝟎 ⎟ ⇒ lim.
x x x x 𝐱H = 100
x x x x x x x x ➞0
⎝ √𝟓𝟎 ⎠
-

⬚ Limit
100% 𝐱H O 𝒙3
𝐗

Q Q Q Q Q
O
𝐗𝟏 O
𝐗𝟐 O
𝐗𝟑 O
𝐗𝟒 O
𝐗𝐧 Central
𝐒𝟏 𝐒𝟐 𝐒𝟑 𝐒𝟒 𝐒𝐧
Q 𝐱H, s
Q 𝐱H, s
Q s
𝐱HM.M151573199.
Q 𝐱H s
Q 𝐱H s 𝑺#
Z √𝒏 \
-

𝐱H 𝐱H X𝐬# Y 𝐱H √𝒏
𝐱H 𝐱H
𝛔= √𝐧 𝐱H 𝛔−
√𝐧 𝐱H √𝐧

5
 Last Revised: 04/25/2024

1. Sample size 63
Sample mean 15 test stat.
𝟏𝟓 − 𝛍
95% CI O ± 𝟏. 𝟗𝟔(𝐬# )
𝑿 𝐳= 𝐬
√𝐧 # 𝐧
√

Descriptive Statistics/
O
𝐗 𝐒
sample
𝐱H 𝒔
Inferential Statistics/

O
𝐗 𝐬#
√𝐧

-
O 𝐱/
𝐗 𝐬#
√𝐧

19. A sample mean is computed from a population with a variance of 2.45. The
sample size is 40. The standard error of the sample mean is closest to:

n = 40 𝝈𝟐 = 2.45
A. 0.039.
SE = 𝐬#
B. 0.247. √𝐧
C. 0.387. = √𝟐. 𝟒𝟓k
√𝟒𝟎
= 2.4748

M.M151573199.

6
 Last Revised: 04/25/2024

24. For a sample size of 17, with a mean of 116.23 and a variance of 245.55,
the width of a 90% confidence interval using the appropriate
t-distribution is closest to:
n = 17 O = 116.23
𝒙 s2 = 245.55 Desc.
A. 13.23.

B. 13.27. O +⁄− 𝐭 .𝟎𝟓,𝟏𝟎 × 𝐬#

𝐗
√𝐧
C. 13.68.
𝐱H 𝐱/ X𝟏. 𝟕𝟒𝟔 × 𝟏𝟓. 𝟔𝟕# Y × 𝟐 = 𝟏𝟑. 𝟐𝟕𝟏𝟒𝟔
√𝟏𝟕
25. For a sample size of 65 with a mean of 31 taken from a normally
distributed population with a variance of 529, a 99% confidence interval
for the population mean will have a lower limit closest to:

A. 23.64. n = 65 𝐱H = 31 𝝈2 = 529
B. 25.41. 𝐬# O ± 𝐙.𝟎𝟎𝟓 × 𝐬#
𝐗
√𝐧 √𝐧
C. 30.09. √𝟓𝟐𝟗
𝚺(𝐗 − 𝐗 𝐱 )𝟐 31 ± 2.58 o p - L -23.64
√𝟔𝟓

M.M151573199.

7
 Last Revised: 04/25/2024

Testing Means versus Testing Variances

Testing Means
· t-test (always correct) - if n > 30, can use z-test
< 30, non, normal
𝐱H − 𝛍𝟎
𝐭 𝐝𝐟 = 𝐬
# 𝐧 ➞ standard error - for n > 200 t-dist. ➞ z-dist.
√

critical value: 𝐭 𝛂 , n - 1 one tailed

𝐭 𝛂8𝟐 , n - 1 two-tailed H a : 𝛍 ≠ 𝛍𝟎 𝟐
H a : 𝛍 < 𝛍𝟎 𝐋
H a : 𝛍 > 𝛍𝟎 𝐑

t-dist. standard normal dist.

df = 175 (z)

t-dist.
df = 100
M.M151573199.

t-dist.
df = 25
-

𝛍=𝟎 𝛔=𝟏
reject reject
do not reject
8
 Last Revised: 04/25/2024

Testing Variances
· single variance, - distributed as a X2 variable
X2 test (chi-square)
- bounded below by 0 (no negative values)

𝐧−𝟏 · sensitive to violations of

𝑿𝟐 = assumptions
𝝈𝟐𝟎
· if sample is not random
does not come from
normal dist. pop.
· 2 variances ➞ then inference likely to
be faulty
𝒔𝟐𝟏 n1 - 1
𝐅 − 𝐭𝐞𝐬𝐭 = df - large s2 in the num.
𝒔𝟐𝟐 n2 - 1

bounded by zero

bounded by zero M.M151573199.

± 1.96
-

9
 Last Revised: 04/25/2024

𝐇𝐚 : 𝐒 𝟐 < 𝛔𝟐𝟎

M.M151573199.

𝐬𝟏𝟐 n -1
𝐅= 𝟐
𝐬𝟐 n - 1

5%

10
 Last Revised: 04/25/2024

CML vs. SML

E(Rp) E(R)
f(ability, willingness)

high RT B ski-hill
(CML)
CAL A golf course
140%
𝝈
E(Rm)
low RT optimal portfolio
pro/y - market port.
50%
- equity index
SnP500
50%
rf

𝛔𝐏
0 x 𝛔𝐦 total risk
𝐄(𝐑 𝐦 − 𝐫𝐟 ) Passive Investor!
𝐄w𝐑 𝐩 x = 𝐫𝐟 + × 𝛔𝐏
𝛔𝐦
y = a + bx E(Ri) = 501
𝝈𝟐 = 501
[𝟓𝟎𝟏(𝟓𝟎𝟎)]#
Cov. = 𝟐

𝐄(𝐑 𝐦 − 𝐫𝐟 )
𝐄(𝐑 𝐢 ) = 𝐫𝐟 + { | × 𝛔𝐢 multiplied by how much
𝛔𝐦
risk we are willing
risk-adjusted to take on
return on the market
𝛔𝐢
𝐄(𝐑 𝐢 ) − 𝐫𝐟 = #𝛔𝐦 [𝐄(𝐑 𝐦 − 𝐫𝐟 )]
diversifiable
M.M151573199.
𝐭𝐨𝐭𝐚𝐥 𝐬𝐞𝐜𝐮𝐫𝐢𝐭𝐲 𝐫𝐢𝐬𝐤 𝐬𝐲𝐬. + 𝐧𝐨𝐧 − 𝐬𝐲𝐬. 𝐫𝐢𝐬𝐤
=
𝐭𝐨𝐭𝐚𝐥 𝐦𝐚𝐫𝐤𝐞𝐭 𝐫𝐢𝐬𝐤 𝐬𝐲𝐬. 𝐫𝐢𝐬𝐤

𝛃 × 𝛔𝐦
= =𝛃
𝛔𝐦

𝐄(𝐑 𝐢 ) − 𝐫𝐟 = 𝛃[𝐄(𝐑 𝐦 − 𝐫𝐟 )]
𝐄(𝐑 𝐢 ) = 𝐫𝐟 − 𝛃[𝐄(𝐑 𝐦 − 𝐫𝐟 )] - CAPM
11
 Last Revised: 04/25/2024

E(Ri)
E(Rp) = ΣwiE(Ri)
SML 𝛃𝐩 - Σwi𝛃𝐢

- adding assets to
m the portfolio only
E(Rm)
requires an estimate
of systematic risk
(𝛃 𝐢 )

rf

𝛃𝐢 · 𝜷𝒑 is a linear
0 𝛃𝐦 combination of
𝐂𝐨𝐯(𝐑 𝐢 , 𝐑 𝐦 ) 𝛒𝐢𝐦 𝛔𝐢 𝛔𝐦 𝛔𝐢 the individual
𝛃𝐢 = = = 𝛒
𝛔𝟐𝐦 𝛔𝐦 𝛔𝐧 𝐢𝐦
𝛔𝐦 𝜷𝒊 ’s

𝐄(𝐑 𝐦 − 𝐫𝐟 )
𝐄(𝐑 𝐢 ) = 𝐫𝐟 + × 𝛔𝐩 𝐄(𝐑 𝐢 ) = 𝐫𝐟 + 𝜷𝒊 [(𝐑 𝐦 ) − 𝐫𝐟 ]
𝛔𝐦

- for efficient portfolios - all securities

only (eff. + non-eff.)
E(R) E(R)
passive active
CML SML

M.M151573199.

rf rf

0 𝛔𝐦 ~𝟏𝟗% 𝛔 0 𝛃𝐦 = 𝟏 𝛔

12
 Last Revised: 04/25/2024

- Performance: 𝛔𝟐 = 𝟎 · no risk

Sharpe ratio: 𝐑 𝐩 −𝐫𝐟

eff. CML 𝛔𝐩 - total risk
➞ used to assess any portfolio/security
𝛔 SnP500
Treynor Ratio: 𝐑 𝐩 −𝐫𝐟 enhanced index fund 𝛃=𝟎 · no risk?
𝛃𝐩 ➞ systematic risk only
SML ➞ used to assess well diversified
portfolios only
𝜷

Biotechnology 𝛃 = .𝟏

M.M151573199.

13
 Last Revised: 04/25/2024

DTA and DTL

Accounting Profit vs. Taxable Income

(EBT)

10,000 Income 10,000

-5,000 Exp. -4,000
EBT 5000 6,000 Taxable
Income
2000 40% -2400
3000 3600

Journal Entry/
DR CR ITE < ITP
Income Tax Exp. 2000
Income Tax Payable 2400 ITE + DTA = ITP
Def. Tax Asset 400 ITE = ITP - DTA
2400 2400
ITE = [ITP - DTA] + DTL

Accounting Profit vs. Taxable Income

(EBT)

10,000 Income 10,000

-4,000 Exp. -5,000
EBT 6,000 6,000 Taxable
Income
ITE -2,400 40% t -2,000 ITP
3,600 3,000

Journal Entry/
M.M151573199.
DR CR ITE > ITP
Income Tax Exp. 2400 ITE = ITP + DTL
Income Tax Payable 2000
DTL 400

ITE = [ITP - 𝚫DTA] + 𝚫DTL

14
 Last Revised: 04/25/2024

Accounting Profit vs. Taxable Income

(EBT)

Income Statement A Balance Sheet

(DR) + DR (CR)
ITE < ITP + DR - DTA
ITE > CR ITP + CR + DTL
L
DR
Reportable < Taxable
A A L
Income Income
EBT +40% -40% DR CR

Reportable > Taxable

Income CR Income <
L >

EBT < Tax Inc.

DTA
ITE < ITP
EBT <
1. EBT - $10,693 DTA 5. Rep. Exp. 10k DTA
> ➝ CR ? Tax Inc. ?
DTL DTL
Tax Inc. - $9,432 Tax Exp. 9k
EBT
2. EBT = 20k DTA 6. Rep. Exp. 12k DTA
? = ?
DR ← <
DTL Tax Exp. 12k DTL
Tax Inc.
Tax Inc. = 25k

3. ITE = 4200 7. Rep. Exp. 5k A

DTA ?
DR ← < 6k B
DTL
TP = 6300 11k DTA
EBT
?
Tax Exp. 6k A DTL
4. ITE = 10 DTA ?
M.M151573199.= 5k B
> ➝ CR Tax Inc.
DTL 11k
ITP = 7

15
 Last Revised: 04/25/2024

Carry Value vs. Tax Base (asset only)

$100k asset Financial Tax
10 yr. useful life Reporting Reporting
- st. line - 2x
$10k $20k
Carrying Value Tax Base
EBT > Taxable $80,000
$90,000
Income

ITC > TP
(DR) (CR) +(CR)
= DTL

C > CR
TB DTL

C - TB = 90 - 80 = 10k DTL = 10k × t

= 4000

2011
DR CR ITE = ITP + 𝚫DTL - 𝚫DTA
ITE ITP (?)
A L
DTA DTL 10 11 10 11
DTA - - DTL - -
ITE = ITP - DTA + DTL
ITE = ITP - 𝚫DTL + 𝚫DTA
> points towards <
CR DR
EBT > Tax Inc. EBT < Tax Inc.
ITE > TP ITE < TP
C > TB C < TB
DTL M.M151573199.

DTA

16
 Last Revised: 04/25/2024

EBT > Tax Inc.

ITE > TP DTL
asset C > TB
only

Liability ➞ think of it this way: a negative asset is a liability

asset C > TB DTL A C > TB L

10 5 A C < TB A
- C < - TB DTA L C > TB A
-10 -5 L C < TB L
-C < -TB L

3. Income tax expense reported on a company’s income statement equals taxes

payable, plus the net increase in:
ITE = TP + 𝚫DTL - 𝚫DTA
A. deferred tax assets and deferred tax liabilities.

B. deferred tax assets, less the net increase in deferred tax liabilities.

C. deferred tax liabilities, less the net increase in deferred tax assets.

4. Analysts should treat deferred tax liabilities that are expected to reverse as:

A. equity.

B. liabilities.

C. neither liabilities nor equity.

M.M151573199.

17
 Last Revised: 04/25/2024

ITE TP

2. Which statement is correct?

A
CR DR
a. When tax payable > tax expense, this creates a DTA
𝐉𝐄
b. When tax payable > tax expense, this creates a DTL
𝐈𝐓𝐏 $
c. When tax payable < tax expense, this creates a DTA
CR cash $
L
3. Income Taxes Paid, an outflow in CFO, reduces:

a. Income Tax Payable ITP

b. Income Tax Expense
c. Deferred Tax Liability
C
4. A company reports its PPE at $180K for financial reporting purposes but
the asset class has a tax base of $160K. Given a tax rate of 30%, this
situation results in a: TP

a. $6,000 DTA C > TB

b. $20,000 DTL CR
c. $6,000 DTL L
(C - TB) t (180 - 160) t

5. Which statement is FALSE?

a. All DTA/DTL are noncurrent under IFRS

b. DTA/DTL may be either current or noncurrent under US GAAP
c. All DTA/DTL are current under IFRS

6. Research costs of $2M are expensed in the current year for financial
reporting purposes but for tax purposes, this amount must be claimed over 2
years. This will result in M.M151573199. FR TR
A L A L
a. Tax base < carrying value RC ∅
RC 1M
b. Tax base > carrying value
c. The creation of a DTL account
DR C TB
0
< 1M
A

18
 Last Revised: 04/25/2024

7. Unearned revenue of $500,000 is reported as a liability for year-end. For

tax purposes, there is no unearned revenue and thus the amount must be
claimed as current period taxable income. With a 35% tax rate, this sets up a:
A DR
a. DTA of $350,000 EBT < Tax.Inc. Inc. (C - TB) t
b. DTL of $175,000 A L A L
c. DTA of $175,000 C = Un.Rev. 500,000 > TB = ∅
A
8. Donations made of $1M in the current period to various charities are only
75% deductible for tax reporting purposes. This will set up a:

a. DTA
b. DTL
c. Neither a DTL nor a DTA

9. With respect to an increase in the statutory tax rates within a jurisdiction,

reporting companies would experience: t
a. An increase in their DTL and a decrease in their DTA DTA DTL
b. A decrease in their DTL and an increase in their DTA
c. An increase in both their DTA and DTL

10. A company reports current DTA of $45K, non-current DTA of $100K, current
DTL of $32K, and noncurrent DTL of $55K. What is the effect on the net tax
position of a 7% decrease in tax rates? 145 DTA
a. An increase in tax benefits of $4,060 87 DTL
b. A decrease in tax benefits of $4,060 58k DTA × .07
c. A decrease in tax benefits of $3,150 = 4060
11. A company reports gross DTA balances that equal their gross DTL
balances. With respect to changes in tax rates, which would the company
rather have occurred?
a. A decrease in tax rates
∅
b. An increase in tax rates
c. Since net tax assets (or liabilities) = $0, the company would be
M.M151573199.

indifferent to a tax increase or decrease TR

12. Tax credits would have the following effect on deferred taxes. Income
a. A tax credit reduces the balance in the DTL - Exp.
b. A tax credit increases the balance in the DTA EBT Tax. Inc.
c. A Credit has no effect on deferred taxes x x
Tax Payable
- CR
19
 Last Revised: 04/25/2024

Financial Reporting Tax Return

Assets Liabilities Assets Liabilities

C = TB
PPE 100K PPE $100K
Accm.Dep. 10K Wage Payable $ Wages Payable $ ∅
Accm.Dep. 20K
C - 90K TB - 80K
Un.Rev. $10K Un.Rev. $0K
C TB
C = 0 Cap. R&D $1M

C = 0 TB = 0

A
C < TB
Wage Exp. $
Cash $

M.M151573199.

20
 Last Revised: 04/25/2024

Full and Flat Prices and Matrix Pricing

T T T

PMT
- PMT PMT PMT

-
PV = ?
t
𝐏𝐌𝐓 𝐏𝐌𝐓 𝐏𝐌𝐓
𝐏𝐕 𝐟𝐮𝐥𝐥 = 𝟏1𝐭
+ 𝟐1𝐭
+ 𝟑1𝐭8
(𝟏 + 𝐫) 8𝐓 (𝟏 + 𝐫) 8𝐓 (𝟏 + 𝐫) 𝐓

𝐭 𝐭 𝐭
𝐏𝐌𝐓(𝟏 + 𝐫) 8𝐓 𝐏𝐌𝐓(𝟏 + 𝐫) 8𝐓 (𝐏𝐌𝐓 + 𝐅𝐕)(𝟏 + 𝐫) 8𝐓
= + +
(𝟏 + 𝐫) (𝟏 + 𝐫)𝟐 (𝟏 + 𝐫)𝟑

𝐏𝐌𝐓 𝐏𝐌𝐓 𝐏𝐌𝐓 + 𝐅𝐕 𝟏1𝐭

=Œ + + • (𝟏 + 𝐫) 8𝐓
(𝟏 + 𝐫) (𝟏 + 𝐫) 𝟐 (𝟏 + 𝐫)𝟑

proof: 𝐏𝐌𝐓 × 𝑿𝟐 𝐏𝐌𝐓 × 𝐗 × 𝐗 𝐏𝐌𝐓 𝐏𝐌𝐓

= = 𝟐 = 𝟒1𝟐
𝐗𝟒 𝐗×𝐗×𝐗×𝐗 𝑿 𝑿

𝐏𝐌𝐓
𝑿𝟒1𝟐

T T T

PMT PMT PMT PMT

-

PV = ?
t 𝐏𝐌𝐓 𝐏𝐌𝐓 𝐏𝐌𝐓
𝐏𝐕 𝐟𝐮𝐥𝐥 = 𝟏1𝐭
+ 𝟐1𝐭
+ 𝟑1𝐭8
(𝟏 + 𝐫) 8𝐓 (𝟏 + 𝐫) 8𝐓 (𝟏 + 𝐫) 𝐓

𝐭 𝐭 𝐭
𝐏𝐌𝐓(𝟏 + 𝐫) 8𝐓 𝐏𝐌𝐓(𝟏 + 𝐫) 8𝐓 (𝐏𝐌𝐓 + 𝐅𝐕)(𝟏 + 𝐫) 8𝐓
= + +
(𝟏 + 𝐫) (𝟏 + 𝐫)𝟐 (𝟏 + 𝐫)𝟑
M.M151573199.

𝐏𝐌𝐓 𝐏𝐌𝐓 𝐏𝐌𝐓 + 𝐅𝐕 𝐭

=Œ + + • (𝟏 + 𝐫) 8𝐓
(𝟏 + 𝐫) (𝟏 + 𝐫)𝟐 (𝟏 + 𝐫) 𝟑

𝐭
𝐏𝐕 𝐟𝐮𝐥𝐥 = 𝐏𝐕(𝟏 + 𝐫) 8𝐓

- AI = PVflat

21
 Last Revised: 04/25/2024

𝐭
𝐏𝐕 𝐟𝐮𝐥𝐥 = 𝐏𝐕 𝐟𝐥𝐚𝐭 + 𝐀𝐈 = 𝐏𝐕(𝟏 + 𝐫) 8𝐓
e.g./ · 5% semi
Feb 15 Aug 15 Feb 15
· matures Feb. 15/2024

-
· 𝐚𝐜𝐭𝐮𝐚𝐥#𝐚𝐜𝐭𝐮𝐚𝐥 day count 2015 2015 2024
· coupons: 15th Feb & Aug
· settles May 14/2015 May 14 PVflat
· I/Y = 4.8% t = 13 + 31 + 30 + 14 = 88 days
T = 13 + 31 + 30 + 31 + 30 + 31 + 15
= 181 days

N = 18 CPT PV = 101.44779
𝟖𝟖8
PMT = 2.5 × (𝟏. 𝟎𝟐𝟒) = 𝟏𝟎𝟐. 𝟔𝟐𝟒𝟑𝟐𝟑
𝟏𝟖𝟏

FV = 100 PVfull
I/Y = 2.4 𝟏𝟎𝟐. 𝟔𝟐𝟒𝟑𝟐𝟑 = 𝐏𝐕 𝐟𝐥𝐚𝐭 + 𝟖𝟖#𝟏𝟖𝟏 (𝟐. 𝟓)

𝐏𝐕 𝐟𝐥𝐚𝐭 = 𝟏𝟎𝟏. 𝟒𝟎𝟖𝟖𝟓𝟑

Matrix Pricing/ · illiquid bonds

· not yet issued
e.g./ 3 yr., 4% semi ⇒ comparable bonds
· 2y, 3% semi @ 98.50
2% 3% 4% 5% Aug. · 2y, 5% semi @ 102.25
2y ✓ ✓ 3.8035% · 5y, 2% semi @ 90.25
3.786% 3.821% · 5y, 4% semi @ 99.125
3y X X
4y
5y ✓ ✓ 4.1885%
4.181% 4.196% 𝟑−𝟐 𝟏
= #𝟑
𝟓−𝟐
M.M151573199.

N = 6 I/Y = 𝟑. 𝟗𝟑𝟏𝟖#𝟐
PMT = 2 𝟑. 𝟖𝟎𝟑𝟓 + 𝟏#𝟑 (𝟒. 𝟏𝟖𝟖𝟓 − 𝟑. 𝟖𝟎𝟑𝟓)
FV = 100 CPT PV = 100.191
= 𝟑. 𝟗𝟑𝟏𝟖%

22
 Last Revised: 04/25/2024

Why use Full Price when calculating ApproxModDur?

𝐏𝐕1 − 𝐏𝐕D 𝟏𝟎𝟗. 𝟏𝟔 − 𝟏𝟎𝟎

𝐀𝐩𝐩𝐫𝐨𝐱𝐌𝐨𝐝𝐃𝐮𝐫 = = = 𝟒. 𝟑𝟖𝟒𝟖
𝟐 × 𝚫𝐲𝐢𝐞𝐥𝐝 × 𝐏𝐕𝟎 𝟐 ×. 𝟎𝟏 × 𝟏. 𝟎. 𝟒𝟓𝟐

N = 5, PMT = 5, I/Y = 4, FV = 100 P0 = 104.452 + $AI

PV- = 109.16
PV+ = 100
Assume AI of #1
𝟏𝟏𝟎. 𝟏𝟔 − 𝟏𝟎𝟏
= 𝟒. 𝟑𝟒𝟑𝟐
𝟐 ×. 𝟎𝟏 × 𝟏𝟎𝟓. 𝟒𝟓𝟐

① MVP = 104.452 w/o AI ② MVP = 105.452

- D 4.58 -D 4.580
99.872 100.872
+ AI 1
100.872

M.M151573199.

23
 Last Revised: 04/25/2024

Duration and Convexity

10 yr., 8% annual bond, YTM = 10.40% , PV = 85.503075

0 5 10
7.0029
Macaulay
- if r ↑, PV ↓, but reinvestment ↑ Duration
r↓, PV ↑, reinvestment↓ (MacDur)

Interpretation: for a single instantaneous move in

interest rates of 100 bps, it takes 7.0029 periods such
that price risk = reinvestment risk
- at that point in time, the investor realizes the original
YTM of 10.4%
𝐌𝐚𝐜𝐃𝐮𝐫 M.M151573199.

= 𝐌𝐨𝐝𝐃𝐮𝐫 − 𝐌𝐨𝐝𝐢𝐟𝐢𝐞𝐝 𝐃𝐮𝐫𝐚𝐭𝐢𝐨𝐧

(𝟏 + 𝐫)
per period
𝐀𝐧𝐧𝐌𝐨𝐝𝐃𝐮𝐫 = 𝐌𝐨𝐝𝐃𝐮𝐫, 𝐚𝐧𝐧𝐮𝐚𝐥𝐢𝐳𝐞𝐝

24
 Last Revised: 04/25/2024

AnnModDur
Interpretation: provides an estimate of the %𝚫PVfull
given a change in its YTM
%𝚫𝐏𝐕𝐟𝐮𝐥𝐥 ≈ −𝐀𝐧𝐧𝐌𝐨𝐝𝐃𝐮𝐫 × 𝚫𝐲𝐢𝐞𝐥𝐝 if r ↓, PV ↑
(- × -) =+
(- × +) =-
if r ↑, PV ↓

e.g./ MacDur = 9 𝟗
𝐌𝐨𝐝𝐃𝐮𝐫 = = 𝟖. 𝟒𝟗
r = 6% 𝟏. 𝟎𝟔
%𝚫𝐏𝐕𝐟𝐮𝐥𝐥 = −𝟖. 𝟒𝟗 ×. 𝟎𝟏𝟎𝟎 = −. 𝟎𝟖𝟒𝟗
- estimated loss in PV is - 8.49%

𝟏𝟐 𝟏𝟏. 𝟓𝟗𝟒𝟐
MacDur = 12 𝐌𝐨𝐝𝐃𝐮𝐫 = = 𝟏𝟏. 𝟓𝟗𝟒𝟐 𝐀𝐧𝐧𝐌𝐨𝐝𝐃𝐮𝐫 = = 𝟓. 𝟕𝟗𝟕
𝟏. 𝟎𝟑𝟓 𝟐
(8 yr., semi)
𝟔
r = 7% 𝐍𝐨𝐭𝐞 = = 𝟓. 𝟔𝟎𝟕𝟒
𝟏. 𝟎𝟕

y
abs m = 2
∴ if y = 10, for a 1 unit change
y = 2x in x, y changes by 2

12
x 10 or by
𝟐
= 𝟐𝟎%
𝟏𝟎
8
𝚫𝐲 𝚫𝐲
𝟐= 𝚫𝐱
𝚫𝐱 𝐨𝐫𝐢𝐠. 𝐲

· if y = 20, for a 1 unit change in 𝚫𝐏𝐕 𝐏𝐕1 − 𝐏𝐕D

X Y
𝟐 𝚫𝐫 𝟐𝚫𝐲𝐢𝐞𝐥𝐝 × 𝑷𝟎
x, y changes 𝟐𝟎
= 𝟏𝟎% 𝑷𝟎
- Slope = sensitivity of y for changes in x, at a given
value of y
M.M151573199.

25
 Last Revised: 04/25/2024

PV 5%, 5 yr., semi @ 98.65 N = 10

PMT = 2.5 I/Y = 5.311%
what is the slope of this line? FV = 100
PV = 98.65
PV- 𝚫𝐲 𝐏𝐕1 − 𝐏𝐕D
=
𝚫𝐱 𝟐𝚫𝐲𝐢𝐞𝐥𝐝
y
PV0 = 98.65 - if PV = 98.65, for a 100 bps
change in r, y change by
PV+
𝐏𝐕1 − 𝐏𝐕D
𝟐𝚫𝐲𝐢𝐞𝐥𝐝 𝟏
×
𝑷𝟎 𝟏 𝑷𝟎
𝟏 × 𝑷𝟎
5.311 r

-100bps +100bps 𝐏𝐕1 − 𝐏𝐕D

𝐀𝐩𝐩𝐫𝐨𝐱𝐌𝐨𝐝𝐃𝐮𝐫 =
𝟐𝚫𝐲𝐢𝐞𝐥𝐝 × 𝐏𝟎

𝐌𝐚𝐜𝐃𝐮𝐫
So, 𝐌𝐨𝐝𝐃𝐮𝐫 =
𝟏+𝐫
linear
𝐀𝐧𝐧𝐌𝐨𝐝𝐃𝐮𝐫 = 𝐌𝐨𝐝𝐃𝐮𝐫 𝐚𝐧𝐧𝐮𝐚𝐥𝐢𝐳𝐞𝐝
estimates
of PV 𝐏𝐕1 − 𝐏𝐕D TVM keys
𝐀𝐩𝐩𝐫𝐨𝐱𝐌𝐨𝐝𝐃𝐮𝐫 =
sensitivity 𝟐𝚫𝐲𝐢𝐞𝐥𝐝 × 𝐏𝟎
to 𝚫yield already annualized

- if we have ModDur, MacDur = ModDur (1 + r)

ApproxModDur, ApproxMacDur = ApproxModDur (1 + r)

Q: What is 𝐏𝐕1 − 𝐏𝐕D ?

𝟐 × 𝚫𝐜𝐮𝐫𝐯𝐞 × 𝐏𝐕𝟎

EffDur callable
M.M151573199.
puttable
-

26
 Last Revised: 04/25/2024

–𝟏#𝟐 × 𝐀𝐧𝐧𝐂𝐨𝐧𝐯𝐞𝐱𝐢𝐭𝐲 × (𝚫𝐲𝐢𝐞𝐥𝐝)𝟐 —

𝐏𝐕1 − 𝐏𝐕D − [𝟐𝐏𝐕𝟎 ]

𝐀𝐩𝐩𝐫𝐨𝐱𝐂𝐨𝐧 =
(𝚫𝐲𝐢𝐞𝐥𝐝)𝟐 × 𝐏𝐕𝟎

∴ %𝚫𝐏𝐕𝐟𝐮𝐥𝐥 =
[(−𝐀𝐧𝐧𝐌𝐨𝐝𝐃𝐮𝐫 × 𝚫𝐲𝐢𝐞𝐥𝐝)]
+–𝟏#𝟐 𝐀𝐧𝐧𝐂𝐨𝐧 × (𝚫𝐲𝐢𝐞𝐥𝐝)𝟐 —

convexity adjustment

𝐌𝐚𝐜𝐃𝐮𝐫
𝐌𝐨𝐝𝐃𝐮𝐫 = , 𝐚𝐧𝐮𝐮𝐮𝐚𝐥𝐢𝐳𝐞𝐝
𝟏+𝐫
𝐏𝐕1 − 𝐏𝐕D
𝐀𝐩𝐩𝐫𝐨𝐱𝐌𝐨𝐝𝐃𝐮𝐫 =
𝟐𝚫𝐲𝐢𝐞𝐥𝐝 × 𝐏𝟎

∴ %𝚫𝐏𝐕𝐟𝐮𝐥𝐥 = (−𝐀𝐧𝐧𝐌𝐨𝐝𝐃𝐮𝐫 × 𝚫𝐲𝐢𝐞𝐥𝐝) + –𝟏#𝟐 𝐀𝐧𝐧𝐂𝐨𝐧 × (𝚫𝐲𝐢𝐞𝐥𝐝)𝟐 —

- inputs
𝐏𝐕1 − 𝐏𝐕D − 𝟐𝐏𝐕𝟎
PV0 𝐀𝐩𝐩𝐫𝐨𝐱𝐂𝐨𝐧 =
(𝚫𝐲𝐢𝐞𝐥𝐝)𝟐 × 𝐏𝐕𝟎
PV-
PV+
𝚫yield
MoneyDur = AnnModDur × PV0 - also called
MoneyCon = AnnCon × PV0 Dollar Duration

%𝚫𝐏𝐕𝐟𝐮𝐥𝐥 = (−𝐌𝐨𝐧𝐞𝐲𝐃𝐮𝐫 × 𝚫𝐲𝐢𝐞𝐥𝐝) + –𝟏#𝟐 𝐌𝐨𝐧𝐞𝐲𝐂𝐨𝐧 × (𝚫𝐲𝐢𝐞𝐥𝐝)𝟐 —

M.M151573199.

27
 Last Revised: 04/25/2024

Why are ModDur and EffDur

different for the same bond?

Par rates spot

1 yr. 2.2% 2.20% 5 yr., 4% annual bond
2 yr. 2.6% 2.605221% PV = 100.444356
3 yr. 3.0% 3.016357% N = 5, FV = 100, PMT = 4,
4 yr. 3.40% 3.456533% PV = -100.444356
5 yr. 3.90% 3.975651%
CPT I/Y = 3.9004645%
- 1% + 1% - 1% + 1%
- caluculate new - calculate new 105.0498935 96.0907098
spots spots 𝐏𝐕 1 − 𝐏𝐕 D
105.095743 96.012392 = 𝟒. 𝟒𝟓𝟗𝟕𝟕𝟒𝟔
𝟐 × 𝚫𝐲𝐢𝐞𝐥𝐝 × 𝐏𝐕𝟎
𝐏𝐕 1 − 𝐏𝐕 D ModDur
= 𝟒. 𝟓𝟐𝟏𝟓𝟖𝟑𝟔𝟒
𝟐 × 𝚫𝐜𝐮𝐫𝐯𝐞 × 𝐏𝐕𝟎
EffDur

M.M151573199.

28
 Last Revised: 04/25/2024

- Pricing and Valuation of Forwards and Futures

-
S0 = 100 st = 103.68 T = 6 mos.
rf = 4.1% rf = 4.0%
𝟔8 t = 3 mos.
𝐅𝟎 (𝐓) = 𝟏𝟎𝟎(𝟏. 𝟎𝟒𝟏) 𝟏𝟐
𝟑8
𝐅𝐭 (𝐓) = 𝟏𝟎𝟑. 𝟔𝟖(𝟏. 𝟎𝟒) 𝟏𝟐 = 𝟏𝟎𝟒. 𝟕𝟎
= 𝟏𝟎𝟐. 𝟎𝟑
long position: 104.70 - 102.03 = 2.67

costs = .75¢
PMT = 50¢ PMT = 50¢
-

-
S0 = 32 t = 3 mos. 5 mos. t = 6 mos. T = 8 mos.
rf = 2.2% S0 = 31.68
rf = 2.3%
𝛌𝟏 = . 𝟓k 𝟑 = . 𝟒𝟗𝟕𝟑 𝝀 = . 𝟓k = . 𝟒𝟗𝟗𝟎
(𝟏. 𝟎𝟐𝟐) 8𝟏𝟐 𝟏
(𝟏. 𝟎𝟐𝟑) 8𝟏𝟐
𝛌𝟐 = . 𝟓k 𝟔 = . 𝟒𝟗𝟒𝟔 . 𝟕𝟓w𝟑#𝟖x
(𝟏. 𝟎𝟐𝟐) 8𝟏𝟐 𝛉= k 𝟑 = . 𝟐𝟖
𝛉 = . 𝟕𝟓k = . 𝟕𝟑𝟗𝟐 (𝟏. 𝟎𝟐𝟑) 8𝟏𝟐
𝟖
(𝟏. 𝟎𝟐𝟐) 8𝟏𝟐 𝟑%
𝐅𝐭 (𝐓) = (𝟑𝟏. 𝟔𝟖−. 𝟒𝟗𝟗+. 𝟐𝟖)(𝟏. 𝟎𝟐𝟑) 𝟏𝟐
𝟖% = 𝟑𝟏. 𝟔𝟒
𝐅𝟎 (𝐓) = (𝟑𝟐−. 𝟒𝟗𝟕𝟑−. 𝟒𝟗𝟒𝟔+. 𝟕𝟑𝟗𝟐)(𝟏. 𝟎𝟐𝟐) 𝟏𝟐
= 𝟑𝟐. 𝟐𝟏
long = (31.64 - 32.21) = -.67

S0 = $125
x
-

1 yr.
F0 = ?

Step 1: Borrow $125 + 1 yr. Libor

Step 2: Buy asset for $125
Step 3: Sell the contract M.M151573199.

Step 4: Pay back the loan 125(1 + rf)T

∴ 𝐅𝟎 (𝐓) = 𝐒𝟎 (𝟏 + 𝐫)𝐓 - there would be
no arbitrage
135
𝐅𝟎 (𝐓) > 𝐒𝟎 (𝟏 + 𝐫)𝐓 $130 125 𝐅𝟎 (𝐓) < 𝐒𝟎 (𝟏 + 𝐫)𝐓 130
H L L H
Sell Buy Buy Sell

29
 Last Revised: 04/25/2024

S0 = $125 $5 -$6

-
1 yr.
F0 = ?

1. at initiation, the value of a contract = $0

i.e. V0(T) = 0
𝐅𝟎 (𝐓) = 𝐒𝟎 (𝟏 + 𝐫)𝐓
𝐅𝟎 (𝐓)
= 𝐒𝟎
(𝟏 + 𝐫)𝐓
2. The forward price, F0(T), has nothing to do with
what we expect the future spot price to be at
expiration
i.e. F0(T) is not a function of E(ST)

S0 r T $ -$

1. S0 = 43
rf = 2.1% 𝐅𝟎 (𝐓) = 𝐒𝟎 𝐂(𝟏 + 𝐫)𝐓
𝟔
T = 6 mos. = 𝟒𝟑(𝟏. 𝟎𝟐𝟏) 8𝟏𝟐 = 𝟒𝟑. 𝟒𝟓

2. S0 = 125 𝐅𝟎 (𝐓) = 𝐒𝟎 𝐂(𝟏 + 𝐫)𝐓

rf = 5% = 𝟏𝟐𝟓(𝟏. 𝟎𝟓)𝟏 = 𝟏𝟑𝟏. 𝟐𝟓
T = 1 yr.

𝟑8
3. S0 = 43 𝟒𝟑(𝟏. 𝟎𝟐𝟏) 𝟏𝟐 = 𝟒𝟑. 𝟐𝟐
rf = 2.1%
T = 3 mos.
-

-
M.M151573199.
-

3 6 2

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 Last Revised: 04/25/2024

S0 Div. ST

-
F0 = ?

Step 1: Find PV(Div) [𝛄 = 𝐏𝐕(𝐃𝐢𝐯. )]

𝛄
Step 2: Borrow S0
S0 - 𝛄 S0 - 𝛄 + 𝛄 = S0
Step 3: Pay back first loan when Div. rec.

Step 4: sell asset at time T - ?

Step 5: pay back loan

(𝐒𝟎 − 𝛄)(𝟏 + 𝐫)𝐓 ∴ 𝐅𝟎 (𝐓) = (𝐒𝟎 − 𝛄)(𝟏 + 𝐫)𝑻

S0 = 25 50¢
1. S0 = 25
-

-
Div. ➞ 3 mos. ➞ 50¢
5 mos.
r = 3.6% F0(T)
T = 5 mos.
𝛄 = . 𝟓𝟎k 𝟑 = . 𝟒𝟗𝟓𝟔
(𝟏+. 𝟎𝟑𝟔) 8𝟏𝟐
𝐅𝟎 (𝐓) = (𝐒𝟎 − 𝛄)(𝟏 + 𝐫)𝐓
𝟓8
= (𝟐𝟓−. 𝟒𝟗𝟓𝟔)(𝟏. 𝟎𝟑𝟔) 𝟏𝟐 = 𝟐𝟒. 𝟖𝟕

S0 = 31.64 .73 .73

-

-
2. S0 = 31.64
Div. ➞ 3 mos. ➞ 6 mos. 7 mos.
73¢ 73¢ 𝛄𝟏 = . 𝟕𝟑k 𝛄𝟐 = . 𝟕𝟑k
𝟑 𝟔
r = 2.14% (𝟏. 𝟎𝟐𝟏𝟒) 8𝟏𝟐 (𝟏. 𝟎𝟐𝟏𝟒) 8𝟏𝟐
T = 7 mos. 𝟕8
𝐅𝟎 (𝐓) = (𝐒𝟎 − 𝛄𝟏 − 𝛄𝟐 )(𝟏 + 𝐫)
M.M151573199.
𝟏𝟐

𝟕8
= (𝟑𝟏. 𝟔𝟒−. 𝟕𝟐𝟔𝟏−. 𝟕𝟐𝟐𝟑)(𝟏. 𝟎𝟐𝟏𝟒) 𝟏𝟐

= $𝟑𝟎. 𝟓𝟕

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 Last Revised: 04/25/2024

Storage costs
Div. x

-
S0 = 100 𝛄

Step #1: Borrow S0 + PV(Storage Costs)

𝛉
Step #2: Buy S0, invest 𝛉 @ 𝐫𝐟

Step #3: Sell S0 at time T ➞ ?

Step #4: Pay back loan

𝐅𝟎 (𝐓) = (𝐒𝟎 + 𝛉)(𝟏 + 𝐫)𝐓
𝐅𝟎 (𝐓) = (𝐒𝟎 + 𝛄 + 𝛉)(𝟏 + 𝐫)𝐓

PV($) PV(-$)

S0 = 250 $5
1. S0 = 250
-

-
Storage costs = 2% 10 mos.
𝛉 = 𝟓k = 𝟒. 𝟖𝟕
rf = 3.1% 𝟏𝟎
(𝟏. 𝟎𝟑𝟏) 8𝟏𝟐
T = 10 mos.
𝐅𝟎 (𝐓) = (𝐒𝟎 + 𝛉)(𝟏 + 𝐫)𝐓
𝟏𝟎8
= (𝟐𝟓𝟎 + 𝟒. 𝟖𝟕)(𝟏. 𝟎𝟑𝟏) 𝟏𝟐 = 𝟐𝟔𝟏. 𝟒𝟒

S0 = 100 $6 ($1.25)
-

2. S0 = 100 x
Storage = $1.25 6 mos.
PMT = $6.00 ➞ 3 mos.
T = 6 mos. 𝛄 = 𝟔k 𝟑 = 𝟓. 𝟗𝟖𝟔𝟔
(𝟏. 𝟎𝟎𝟗) 8𝟏𝟐
M.M151573199.

rf = .9% 𝛉 = 𝟏. 𝟐𝟓k = 𝟏. 𝟐𝟒𝟒𝟒

𝟔
(𝟏. 𝟎𝟎𝟗) 8𝟏𝟐

𝐅𝟎 (𝐓) = (𝐒𝟎 − 𝛄 + 𝛉)(𝟏 + 𝐫)𝐓

𝟔8
= (𝟏𝟎𝟎 − 𝟓. 𝟗𝟖𝟔𝟔 + 𝟏. 𝟐𝟒𝟒𝟒)𝟏. 𝟎𝟎𝟗 𝟏𝟐 = 𝟗𝟓. 𝟔𝟗

32
 Last Revised: 04/25/2024

-
S0 = 100 st = 103.68 T = 6 mos.
rf = 4.1% rf = 4.0%
$10 t = 3 mos. 𝐅𝐭 (𝐓) = 𝐒𝟎 (𝟏 + 𝐫)𝐓
𝐅𝟎 (𝐓) = 𝐒𝟎 (𝟏 + 𝐫)𝐓 $12 𝟑8
= 𝟏𝟎𝟑. 𝟔𝟖(𝟏. 𝟎𝟒) 𝟏𝟐
𝟔8
= 𝟏𝟎𝟎(𝟏. 𝟎𝟒𝟏) 𝟏𝟐
= 𝟏𝟎𝟒. 𝟕𝟎
104.70 - 102.03 = $2.67
long = 𝟏𝟎𝟐. 𝟎𝟑
costs = .75¢
PMT = 50¢ PMT = 50¢
-

-
S0 = 32 t = 3 mos. 5 mos. t = 6 mos. T = 8 mos.
rf = 2.2% S0 = 31.68
rf = 2.3%
𝛌𝟏 = . 𝟓𝟎k 𝟑 = . 𝟒𝟗𝟕𝟑 𝛌 = . 𝟓𝟎k = . 𝟒𝟗𝟗
(𝟏. 𝟎𝟐𝟐) 8𝟏𝟐 𝟏
(𝟏. 𝟎𝟐𝟑) 8𝟏𝟐
𝛌𝟐 = . 𝟓𝟎k 𝟔 = . 𝟒𝟗𝟒𝟔 . 𝟕𝟓w𝟑#𝟖x
(𝟏. 𝟎𝟐𝟐) 8𝟏𝟐 𝛉= k 𝟑 = . 𝟐𝟖
𝛉 = . 𝟕𝟓k = . 𝟕𝟑𝟗𝟐 (𝟏. 𝟎𝟐𝟑) 8𝟏𝟐
𝟖
(𝟏. 𝟎𝟐𝟐) 8𝟏𝟐 𝐅𝐭 (𝐓) = (𝟑𝟏. 𝟔𝟖−. 𝟒𝟗𝟗+. 𝟐𝟖)
𝐅𝟎 (𝐓) = (𝐒𝟎 − 𝛄𝟏 − 𝛄𝟐 + 𝛉)(𝟏 + 𝐫)𝐓 𝟑8
× (𝟏. 𝟎𝟐𝟑) 𝟏𝟐
𝟖8
= (𝟑𝟐−. 𝟒𝟗𝟕𝟑−. 𝟒𝟗𝟒𝟔+. 𝟕𝟑𝟗𝟐)(𝟏. 𝟎𝟐𝟐) 𝟏𝟐 = 𝟑𝟏. 𝟔𝟒
= 𝟑𝟐. 𝟐𝟏 31.64 - 32.21 = -.67

M.M151573199.

33
 Last Revised: 04/25/2024

Options Strategies
Calls
p
$0
IV + TV
out of the
money
$25
$25 at the money
$5

$10
$15
in the money
IV + TV
$97

buy X = $75
-
-
-
-
-
-
expiration t
C0 = 22 + TV
increasing TV (9)
$31

$25 Buy

M.M151573199.

x 0
t

34
 Last Revised: 04/25/2024

Calls

p ③ gain (S - x) - C 25.50
T 0

(30-25) -1 = 4 + 50¢
- 100
$26 -50¢
② loss of (ST - x) - C0
$25 Buy C0 = $1.00

① loss of C0 (2500) $500 20%

(100) max loss C0 ($100) $400 400%
(500)

p
profit

$25.75 $100
loss
S0 = $25 50¢

ITM
$85¢ ② IV = $5.00
$20 x = 20 C0 = $5.75
0TM TV = $0.75

C0 = $5.75
M.M151573199. x = 10 = C0 = 15 + TV
x = 5 = C0 = 20 + TV
x = 0 = C0 = 25 ∅
t
upper max S0 2500 575
limit 3 mos. 9 mos.
～ 85%
call

35
 Last Revised: 04/25/2024

Covered Call

belongs to someone else

X = 26
② belongs to us
S0 = 25 - (X - S0) + C0
premium for
profit on call
stock

get C0 today S0 - C0 max loss

S0

50 -
$30 +②TV
$40,000
- x = 20

10 -
-

Nov 30 Dec 31 Jan

M.M151573199. APR.

36
 Last Revised: 04/25/2024

belongs to someone else

X = 26
belongs to us
②
S0 = 25 - (X - S0) + C0
premium for
profit on call
stock

get C0 today S0 - C0 max loss

S0

Protective Put
(Rev.)
payoff (ST - S0)
100 - Exp. - payoff - exp.
300 (ST - S0) - P0
500
25 S0 - ② 1000
belongs to us
deductible
22.50 x -
- belongs to someone else
50¢ -

loss (X - S0) - M.M151573199.

P0 max loss
- 2.50 - 50¢ = 3.00

37
 Last Revised: 04/25/2024

Put-Call parity with Replication and Hedging

So + p = c + Xe-rT - put-call parity

- RS
LS
So = c - p + Xe-rT - synthetic long
𝐗
+1
(𝟏 + 𝐫)
So So
-1 0 +1

max.
Perfect Perfect
div.
Hedge Replication

= -(c - p + Xe-rT) = c - p + Xe-rT

long call, short put
-c + p - Xe-rT
short call, long put
synthetic short

M.M151573199.

38
 Last Revised: 04/25/2024

Why do we multiply sd by the square root of T

𝐒𝐓 𝐒 𝐒 𝐒
𝐒𝐓 = 𝐒𝟎 𝐞𝐫𝐓 #𝐒 = o 𝐓#𝐒 p o 𝐓1𝟏#𝐒 p … o 𝟏#𝐒 p
𝟎 𝐓1𝟏 𝐓1𝟐 𝟎

𝐒𝐓
#𝐒 = 𝐞𝐫𝐓
𝟎 24 = 6 × 4

𝐒 In(24) = In(6) + In(4)

𝐈𝐧 o 𝐓#𝐒 p = 𝐈𝐧(𝐞𝐫𝐓 )
𝐧

𝐒 𝐒 𝐒 𝐒𝐓1𝟏 𝐒
𝐈𝐧 o 𝐓#𝐒 p = 𝐫𝐓 𝐈𝐧 o 𝐓#𝐒 p = 𝐈𝐧 o 𝐓#𝐒 p + 𝐈𝐧 o #𝐒 p + ⋯ + 𝐈𝐧 o 𝟏#𝐒 p
𝟎 𝟎 𝐓1𝟏 𝐓1𝟐 𝟎

rT = rT-1 + rT-2 + rT-3 + … r1

-

-
-
-
-
-
-
-

S0 ST
~𝐍(𝛍𝛔𝟐 )
M.M151573199.

𝐄(𝐫𝐓) = 𝛍 + 𝛍 + 𝛍 + ⋯ + 𝛍
𝐄(𝐫𝐓) = 𝛍𝐓
-
-
-
-

0 T

39
 Last Revised: 04/25/2024

rT = rT-1 + rT-2 + rT-3 + … r1 𝛍 𝛍

r1 r2 rT-2 rT-1

-
-
-

-
-
-
~𝐍(𝛍𝛔𝟐 )
0 T
rT
𝐄(𝐫𝐓) = 𝛍𝐓
𝐕𝐚𝐫(𝐫𝐓) = 𝐕𝐚𝐫(𝐫𝑻1𝟏 ) + 𝐕𝐚𝐫(𝐫𝑻1𝟐 ) + 𝐕𝐚𝐫(𝐫𝑻1𝟑 ) … 𝐕𝐚𝐫(𝐫𝟏 )
= 𝝈𝟐 + 𝝈𝟐 + 𝝈𝟐 … 𝝈𝟐
𝐕𝐚𝐫(𝐫𝐓) = 𝝈𝟐 𝑻
𝐒𝐓 Volatility
𝛔(𝐫𝐓) = 𝛔√𝐓 𝐈𝐧 #𝐒
𝐓1𝟏 sd of the CC returns
𝛔𝟐 = 𝟒𝟎𝟎 𝐓 = 𝟏𝟎
· compute 𝛔𝐝𝐚𝐢𝐥𝐲
𝐕𝐚𝐫(𝐫𝐓) = 𝝈𝟐 𝑻 = 𝟒𝟎𝟎𝟎
· weekly 𝛔𝐝𝐚𝐢𝐥𝐲 √𝟓
𝛔(𝐫𝐓) = √𝟒𝟎𝟎𝟎 = 𝟔𝟑. 𝟐𝟒𝟓𝟓 · monthly 𝛔𝐝𝐚𝐢𝐥𝐲 √𝟐𝟎
𝛔(𝐫𝐓) = 𝛔√𝐓 = 𝟐𝟎√𝟏𝟎 = 𝟔𝟑. 𝟐𝟒𝟓𝟓

𝐕𝐚𝐑 = w𝐄w𝐑 𝐩 x − 𝐙 × 𝛔𝐩 x(−𝟏)𝐍𝐀

𝝁
w𝐄w𝐑 𝐩 x × 𝟐𝟓𝟎 − 𝐙 × 𝛔𝐩 √𝟐𝟓𝟎x(−𝟏)𝐍𝐀

𝝁𝑻 w𝝈√𝑻x
𝝈𝟐 𝑻

M.M151573199.

40