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MAT4210 Financial Mathematics (2009-10)

Assignment 1

Due Date is 2 October 2009. Please put your assignment in the assignment box opposite to
the General Office of the Department of Mathematics (Rm 220, LSB) before 5 p.m.. The
solution will be uploaded at 6 p.m. So no late assignments will be accepted.
In this assignment, assume all interest rate is 0%. Please give your answers within 2 decimal
places whenever necessary.

Answer All Questions

1. The following figure shows the net profit that a trader can get by investing one Euro-
pean option.

20
Profit($)
15

10

0
S(T )
−5

−10

−15

−20
0 10 20 30 40 50 60

Answer the following the questions.

(a) What type is the option? Put or call? Why?


(b) What is the traders status for the option? Holder or writer? Why?
(c) What is the strike price? What is the price of the option?
(d) Draw the expiry payoff diagram of the option.

2. A trader sells a call option with a strike price of $35 and sells a put option with a
strike price of $30. Both options have the same maturity. The call costs $3 and the

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put costs $4. Draw a diagram showing the variation of the traders profit with the
stock price at maturity.

3. A European call option and a put option on a stock both have a strike price of $40
and an expiration date in 3 months. The call price is $3 and the put price is $1. The
current stock price is $41. Identify the arbitrage opportunity open to a trader.

4. Draw the expiry payoff diagrams for each of the following portfolios(in each case all
the options have the same maturity date):

(a) short one share of stock and short one put with strike price E
(b) long one call and long two puts with strike price E
(c) long one put with strike price E − 1, long one put with strike price E + 1 and
short two puts with strike price E.

5. Suppose that c1 , c2 , c3 and c4 are the prices of European call options with strike prices
E1 , E2 , E3 and E4 , respectively, where 0 < E1 < E2 < E3 < E4 and E2 −E1 = E4 −E3 .
All options have the same maturity. Show that c2 + c3 ≤ c1 + c4 .

6. Prove that for all t ≤ T , c(t) ≥ S(t) − E.

7. Two clips of webpage are attached. They show the information of its underlying asset
(Figure 1) and some warrants (Figure 2) . In the row 1 and the row 2 of Figure 2, the
code of the warrants are given as 12PW09 and 12CW09 respectively, it means these
are the warrants (PW/CW) that will expire in December 2009. Column 9 and 11 of
Figure 2 are the premium and the gearing ratio respectively. (Use the latest stock
price and warrant price in the following calculations.)

(a) What are the formulae of the premium of a put warrant, the premium of a call
warrant and the gearing ratio? You may find the definitions from the internet.
Define all the variables clearly.
(b) Compute the premium of the put warrant(12PW09), the premium of a call war-
rant(12CW09) and the corresponding gearing ratio of the two warrants according
to the definitions you found. Compare the results with the values on the webpage.

Figure 1: Information of stock, Yahoo Finance, Sep. 09, 2009

MAT4210 Financial Mathematics 2


Figure 2: Information of warrant, Yahoo Finance, Sep. 09, 2009
MAT4210 Financial Mathematics 3