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# EBF 473 - Spring 2016 Final Exam Name: ___________________________________

The first 5 questions are 20 points each. Note that there is also there is a sixth, extra credit,
question worth 5 points.
Gamma= =(1/2)0.5 exp(-d2/2)/ (S(T-t)0.5).

## Put call parity P = C + Ke-rt - S

If a variable X is distributed normally with mean u and standard deviation , Z=(X-u)/ is
distributed normally with mean 0 and standard deviation 1.
The price of a call option on Weather derivatives is derived as follows:
Let X=the number of standard deviations the strike price is away from the mean.
Y=-0.03X3 + 0.22X2-0.50X+0.4
price =Y*.

## The Black-Sholes option pricing formula is C(S, K,T,t)=SN(d)- Pt(T-t)KN(d- (T-t)0.5)

Where d=[(ln (S/Pt(T-t)K))/( (T-t)0.5)]+0.5 (T-t)0.5

## Implicit volatility first guess formula

1=((ABS(LN(105/100)+.02)*(2/.5))0.5
Implicit volatility update formula
2= 1 [(C1-C*(true)) *(2)0.5 exp(d2/2)/[S0 (T) 0.5]]

## A Normal Distribution chart:

X
-3
-2.9
-2.8
-2.7
-2.6
-2.5
-2.4
-2.3
-2.2
-2.1
-2
-1.9
-1.8
-1.7
-1.6
-1.5

N(X)
0.0013
0.0019
0.0026
0.0035
0.0047
0.0062
0.0082
0.0107
0.0139
0.0179
0.0228
0.0287
0.0359
0.0446
0.0548
0.0668

X
-1.5
-1.4
-1.3
-1.2
-1.1
-1
-0.9
-0.8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0

N(X)
0.0668
0.0808
0.0968
0.1151
0.1357
0.1587
0.1841
0.2119
0.2420
0.2743
0.3085
0.3446
0.3821
0.4207
0.4602
0.5000

1) General Products is somewhat volatile after being forced to relocate. Right now, it sells for
\$55 per share. You are an options writer, and you have written 2000 call options at a strike
price of \$50 on General Products expiring in 18 months. To hedge your position, you can buy
or sell General Products stock, as well as General Products call options with a strike price of
60, expiring in 18 months. The annual standard deviation of General Products stock is 90%.
The interest rate on money is 10%. Explain how much of each asset you will long and short
Hint
K = 50
K = 60
callOtherPosition =

Delta on call
0.7804
0.7285
1781.8

stockPositionDeltaGamma = 262.7

Gamma on call
0.0049
0.0055

2) Go back to problem 1 and use the Black-Sholes equation to price a call option with a strike of
60.
Delta = 0.7285
Price = 24.0244

3) All investors have utility U=Expected Income 5 * Variance of Income. They can invest in
either a safe asset or stock of British Petroleum. British Petroleum stock has an expected
payoff of F and a variance of 0.1. There are 25 shares British Petroleum outstanding. The
interest rate is 0, and all assets pay off next period.
There are 20 investors, but only 10 are British Petroleum fans who think F=2. The
other 10 investors are Royal Dutch Shell fans who think F = 1. What is the market
price of British Petroleum? How much stock does each Royal Dutch Shell fan buy?
Each British Petroleum fan?
Variance = .1(q2)
U = K - qP + qF (.1)(5)q2 = K qP + qF 0.5q2 -- take derivative with respect to q
0 = -P + F q
q=FP
Q = 10(2-P) + 10(1-P)
Q = 30 20P
Market Price:
Q = 25
25 = 30 20P
25 30 = -20P
-5 = -20P
Market Price = .25
qBP = 1*2-1*0.25 = 1.75
qBP = 1*1-1*0.25 = 0.75

4) The long-run cost of oil is 90. The price step size is 1.15. The initial price of gas is one step
below the long-run cost. The well produces 8 units of gas in the first period of drilling and 6
in the second period of drilling. The cost of drilling in the first period is 700. The royalty
rate will be 15%. Let the step coefficient Z=7, so that the probably of an up move is
0.5(7-S)/7. What is the value of the option if you exercise it in the first period and drill now?
mean
price

step size

initai
size

2nd
period
size

90

1.15

1st
period
initial
price

2nd
period
Pr (up)

Pr(down)

78.26

0.57
Price
(up)
90.00
Revenue
s
540.00

0.43
Price(dow
n)
68.05

81.00

61.25

Expecte
d
Revenue
s
262.29

148.74

Initial
position
step
from
mean
-1

Revenue
s
626.09
Royalties
93.91
Cost of
drilling
700.00
Net
revenues
-167.83
Total
revenue
to
producer
if drill
now
243.20

408.32

1st
period
producti
on costs
700

step
coefficie
nt

royal
ty
rate

0.15

Total
revenue
to
landown
er if drill
now
166.45

5) You are buying a strip of call options on January and February HDD in Irkutsk, Russia (yes,
its cold there in the winter) with a strike price of 7000. The expected value of HDDs for
January in Irkutsk is 3250. The standard deviation is 700. In February the expected value is
2800 with a standard deviation of 600. The correlation between these two months is 0.8.
Compute the price of this strip.
strike =
7000
climos =
3250
climo =
6050
stds = 700 600
rho = 0.8000
std = 1.2337e+03
X = 0.7700
Y = 0.1317
price = 162.5173

2800