General Feedback MN3113.

PLEASE NOTE AS ALWAYS YOU ARE MOST WELCOME TO E-MAIL ME TO

MAKE AN APPOINTMENT TO RECEIVE FEEDBACK ON YOUR EXAM. MY EMAIL IS eh76@le.ac.uk.

1. a. =-V+S;
A majority of students got this correct. Other letter changes if they were
consistently applied were also fine.
b. dV=(((V)/(S))S+((V)/(t))+(1/2)((V)/(S))S)dt+(((V)/(S)))Sdz
A majority of you did also answer very well this question.
c.=-((((V)/(S))S+((V)/(t))+(1/2)((V)/(S))S)t+(((V)/(S)))Sz)+
((V)/(S))(St+Sz);
Some students did forget a term in the above. But each term carried individual
marks and was added to the full mark.
d.=((V)/(S));
This was well answered by most students.
e.
=(-((V)/(t))-(1/2)((V)/(S))S)t.
**and if one can assume (()/)(1/(t))=r_{f}:
**(-((V)/(t))-(1/2)((V)/(S))S)t=r_{f}(-V+((V)/(S))S)t
, from where one finds: ((V)/(t))+rS((V)/(S))+(1/2)S((V)/(S))=r_{f}V.
This was surprisingly well answered as this is not an easy question. Marks were
given for various components in the run up of the final Black Scholes partial
differential equation.

2. the argument revolves around the fact that dW/dt is ill defined
There were several ways to answer. Either via the way that dW/dt is ill defined
(the majority of you did so). Or also via the argument the limit to the left and to
the right in the same point do not agree.
3. they typically won't refer to real world events. Just the plain definition of the
risk neutral probability in that theorem tells us that the probability value is a
product of the risk free rate of interest and the state price. Some students did
provide for an example with dice. This question was very well answered.

4. We are not assuming investors are risk neutral. In general well answered
Exam
1.

Question 1

Consider the derivation of the Black-Scholes model.

a.
How is the value of the portfolio defined in that model? Denote with S the
stock price and V the value of the option. [2 marks]
b.

Use Its Lemma to find an expression for dV. [5 marks]

c.
Use the expression you have found in question 1b) to find an expression
for the infinitesimal change in the value of the portfolio. [5 marks]
d.
What is the choice for the Black-Scholes Delta so that the random
component is eliminated from the infinitesimal change in the value of the
portfolio? [3 marks]
e.
Given the choice you indicated for the Black-Scholes Delta, derive now
the Black-Scholes partial differential equation. [15 marks]
[Total: 30 marks]

2.

Question 2

Consider a Brownian motion path (position is on the Y axis and time is on the X
axis). Use the technical (mathematical) argument, as seen in the lecture, which
shows that we cannot find an ordinary mathematical derivative of a stock price
towards time when we consider such a Brownian motion path.
[Total: 30 marks]

3.

Question 3

Consider the non-arbitrage theorem and the use of risk neutral probabilities.
Typically, when we think of probabilities, we think of those mathematical objects
in relation to events. For instance, the probability of the event throwing a one
with a fair six faced dice, is 1/6. Precisely explain why (or why not) the risk
neutral probabilities which are being used in the non-arbitrage theorem refer to a
real world event (or not). [Hint: you can use an example to underline your
explanation.]
[Total: 30 marks]
4.

Question 4

We have seen in the lectures that the option price contains the risk free rate of
interest. Does this mean that we assume, when we price an option, that we live
in a risk free world? Discuss this statement.
[Total: 30 marks]