Professional Documents
Culture Documents
k
X
j=1
v
v
u
u
k
k
uX
uX
u
u
j
t (x1 x
1)2 pj t (xj2 x2 )2pj
j=1
= 1 2 .
j=1
2. a. The arithmetic mean of stock T is (0.29 + 0.18 0.12 0.15 + 0.21)/5 = 0.082.
The arithmetic mean of stock B is (0.18 0.03 0.15 + 0.12 + 0.09)/5 = 0.042.
By the measure of the mean, stock T is preferred.
= 0.1810
= 0.1179
0.0420.02
0.1179
[Note: the solutions with sample mean, that is, when the denominator n = 5 above is
changed to n 1 = 4, are also acceptable.]
3. For 6 months rent: apt A has cash flow (6000, 6000, 6000, 6000, 6000, 6000) and apt B
has cash flow (11000, 5000, 5000, 5000, 5000, 5000, 5000).
PV of apt A =
5
X
k=0
PV of apt B =
6000 +
5
X
k=0
k=0
PV of apt B =
11000 +
11
X
k=1
30
30
30
30
30
+
+
+
+
2
3
4
(1 + r) (1 + r)
(1 + r)
(1 + r)
(1 + r)5
42
42
42
42
42
+
+
+
+
(1 + r) (1 + r)2 (1 + r)3 (1 + r)4 (1 + r)5
30
30
30
30
30
+
+
+
+
= 29.88.
2
3
4
(1 + 0.05) (1 + 0.05) (1 + 0.05) (1 + 0.05) (1 + 0.05)5
For Project 2,
PV = 150+
42
42
42
42
42
+
+
+
+
= 31.84.
2
3
4
(1 + 0.05) (1 + 0.05) (1 + 0.05) (1 + 0.05) (1 + 0.05)5
5. It is known that there is no advantage in buying either the stock or the forward contract
if we can borrow to buy a stock today (so both strategies do not require any initial
cash) and if the profit from this strategy is the same as the profit of a long forward
contract. The profit of a long forward contract with a price for delivery of $53 is equal
to: $ ST $53, where ST is the (unknown) value of one share of CLP at expiration
of the forward contract in one year. If we borrow $50 today to buy one share of CLP
stock (that costs $50), we have to repay in one year: $50(1 + r). Our total profit in
one year from borrowing to buy one share of CLP is therefore: $ST $50(1 + r). Now
we can equate the two profit equations and solve for the interest rate r:
$ST $53
$53
$53
1
$50
r
= $ST $50(1 + r)
= $50(1 + r)
= r
= 0.06
Therefore, the 1-year effective interest rate that is consistent with no advantage to
either buying the stock or forward contract is 6 percent.
6. Please note that we have given the continuously compounded rate of interest as 6%.
Therefore, the effective annual interest rate is exp(0.06) 1 = 0.062. In this exercise,
we need to find the future value of the put premium. For the $0.95-strike put, it is:
$0.0178 1.062 = $0.02.
(a) The diagram for the profit of the company is as follows.
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...
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....
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.
...
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.
...
.
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................................................................................................................................................................................................................................................................................
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...
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...
.
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.
...
.
.
... ......
... ....
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...
copper price
0.9
(b)
Purchased put profit = max{0, strike price copper price}
= max{0, 0.95 copper price}
Profit
($)
.....
......
.. .... ..
....
..
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..
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..
..........
... ......
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.....
...
...
............................................................................................................................................................................................................................................................................
...
........
...
...
..
0.95
Strike price
=
=
=
=
=
copper price
Net income
($)
.
.....
0.0311
0
.....
.. .... ..
....
..
....
..
...
....
.....
....
..
....
.
.
...
.
..
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..
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.
.
..
.
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.
.
..
.
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...
....................................................................................................................
...
.......................................................................................................................................................................................................................................................................
..
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...
...
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..
...
...
...
...
....
..
0.95
Strike price
copper price
7. Our initial cash required to put on the collar, i.e. the net option premium, is as follows:
$51.873 + $51.777 = $0.096. Therefore, we receive only 10 cents if we enter into
this collar. The position is very close to a zero-cost collar.
The profit diagram of holding a long index, long 950 put, and short 1107 call looks as
follows:
Profit
.
.......
87.0979
0
69.9021
...
.. .... ..
...
........................................................................
...
...
...
...
...
...
...
.
...
.
..
...
...
...
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.
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.
..
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...
.............................................................................................................................................................................................................................................................................
.
.
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.
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.
.
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.
.
...
.
.............................................................................
..
...
....
..
...
.
950
Index price
1107
S 950
25.9121,
950 S 1050
= 2S 1925.91,
S + 1224.088, 1050 S,
9. The owner of the stock is entitled to receive dividends. As we will get the stock only
in one year, the value of the prepaid forward contract is todays stock price, less the
present value of the four dividend payments:
P
F0,T
= $50
4
X
$1e0.06 12 i
i=1
10
10. a) We plug the continuously compounded interest rate and the time to expiration in
years into the valuation formula and notice that the time to expiration is 9 months, or
0.75 years. We have:
F0,T = S0 erT = $1,100 e0.050.75 = $1,100 1.0382 = $1,142.02
b) We engage in a reverse cash and carry strategy. In particular, we do the following:
Description
Long forward, resulting
from customer purchase
Sell short the index
Lend +S0
TOTAL
Today
0
In 9 months
ST F0,T
+S0
S0
0
ST
S0 erT
S0 erT F0,T
Today
0
In 9 months
ST $1,142.02
$1,100
$1,100
ST
$1,100 e0.050.75
= $1,142.02
0
Therefore, the market maker is perfectly hedged. She does not have any risk in the
future, because she has successfully created a synthetic short position in the forward
contract.
c) Now, we will engage in cash and carry arbitrage:
Description
Today
Short forward, resulting 0
from customer purchase
Buy the index
S0
Borrow +S0
+S0
TOTAL
0
In 9 months
F0,T ST
ST
S0 erT
F0,T S0 erT
11
Description
Today
Short forward, resulting 0
from customer purchase
Buy the index
$1,100
Borrow $1,100
$1,100
TOTAL
In 9 months
$1, 142.02 ST
ST
$1,100 e0.050.75
= $1,142.02
0
Again, the market maker is perfectly hedged. He does not have any index price risk in
the future, because he has successfully created a synthetic long position in the forward
contract that perfectly offsets his obligation from the sold forward contract.
11. Suppose that the amount deposited in the bank is X0 and the value of the stock after
1
one year is X1 . Then R = X
. The total return of the investment is thus equal to
X0
1.3X0+X1
= 0.65 + 0.5R.
2X0
12. = 0.3, A = 0.15, B = 0.05.
(a) The minimum variance problem is
min 2 A2 + 2(1 )AB + (1 )2 B2 := f().
So
df()
= 2A2 + (2 4)AB 2(1 )B2 = 0.
d
Thus
2AB + 2B2
2A2 4AB + 2B2
AB + B2
=
A2 2AB + B2
= 0.0122,
1 = 0.9878.
=
(b) Minimum SD =
13. (Rain insurance) Let u be the # of units of insurance bought. So the possible outcomes
of return are (.4, u) and (.6, 4 106 ).
(a) The expected rate of return is
.4u+.64106 (106+.5u)
.
106 +.5u
(b) Let X be his return. His mean return is E(X) = (.4u + .6 4 106 ).
The variance of his return is V ar(u) = E(X 2 ) E(X)2 = .4u2 + .6(4 106 )2 (.4u +
.6 4 106 )2.
12
dV ar(u)
= .8u 2(.4u + .6 4 106 ) .4 = .48u 1.92 106 = 0.
du
Then u = 4 106 . So V ar(u) = 0.
4106
106 +2106
1=
4
3
1 = 31 . That is,
or
Rate of return
Prob.
$3M $.5u
$1M +$.5u
.6
$.5u$1M
$1M +$.5u
.4
Var =
wi wj ij
i,j
s.t.
X
j
13
wj = 1.
Since ij = 0, i 6= j, Var =
L(w, ) =
X
j
Then
wj =
=
X
w 2 2 wj
j
1 .
L(w, )
= 2i2wi = 0
wj
.
2j2
So
1
j 22
j
j 22
j
1
= 1. We have
. So wj =
1
j2
P
1
j 2
j
1
, and Var =
1
12
P
1
j 2
j
1
1
j 4
j
1
j 2
j
1
j 2
j
1
2
j2 =
,,
1
2
n
P
1
j 2
j
1
j 2
j
1
1 !
, r .
1
min w> w,
2
s.t.
wj = 1.
wj 1). Thus
w1 + w2
w1 + 2w2 + w3
w2 + 2w3
w1 + w2 + w3
=
=
=
=
0
0
0
1.
Eliminating , we have
w2 w3 = 0
w1 2w3 = 0
w1 + w2 + w3 = 1.
Thus
w2 3w3 = 1,
2w3 = 1
14
=
=
=
=
=
0
0
0
0.7
1.
From the second and third equations, we have w1 + w2 w3 = 0. Thus together with
w1 + w2 + w3 = 1, we have 2w3 = 1, so w3 = 12 .
Multiplying w1 + w2 w3 = 0 by 4 and adding it to 4w1 + 8w2 + 8w3 = 7, we have
4w2 + 12w3 = 7. So w2 = 14 (7 12 12 ) = 14 . Finally we have w1 = 1 41 12 = 14 .
The optimal portfolio solution is w1 = 41 , w2 = 14 , w3 = 12 .
or by the formula:
v1 + v2 = 0.4 0.1
v1 + 2v2 + v3 = 0.8 0.1
v2 + 2v3 = 0.8 0.1.
v1 = 0.4 0.1 2 = 0.2
v2 = 0 0.1 1 = 0.1
v3 = 0.4 0.1 1 = 0.3.
0.2
0.2+0.1+0.3
15
= 13 , w2 =
1
6
and w3 = 12 .
16. We know that the efficient portfolio required in One-Fund Theorem satisfies
n
X
i=1
ki vi = rk rf ,
k = 1, 2, ..., n.
(1)
j=1
ij wj
ri = 0,
i = 1, , n.
ij vj1 1 = 0,
i = 1, , n.
(2)
n
X
ij vj2 ri = 0,
i = 1, , n.
(3)
j=1
j=1
(i) Let = 0, = 1.
Equations are
Solutions are
1v1 + 2v2
= 1
2v1 + 2v2 + v3 = 1
v2 + 2v3 = 1
v11 = .2, v21 = .6, v31 = .2.
Solutions are
1v1 + 2v2
= .1
2v1 + 2v2 + v3 = .2
v2 + 2v3 = .3
v12 = .02, v22 = .06, v32 = .12.
1 2
[w + 2w22 + 2w32 + 2w1 w2 ]
2 1
(3w1 + w2 + w3 2) (w1 + w2 + w3 1) 1 w1 2 w2 3 w3 .
w1 + w2 3 1 = 0
2w2 + w1 2 = 0
2w3 3 = 0
3w1 + w2 + w3 2 = 0
w1 + w2 + w3 1 = 0
1 w1 = 0, 1 0, w1 0,
2 w2 = 0, 2 0, w2 0,
3 w3 = 0, 3 0, w3 0.
18