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Quiz

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You are on page 1of 7

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).

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*.

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

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]]

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

to hedge your portfolio.

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

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