⼀

⼀
⼀ ⼀

⼀
⼀ ⼀

[ a)
Con struet a risk- free portfoho π ,

st
a
position in n
long o d
5 shares of the a short position in the oBtion

k =$ 17 π =$ 19 optionralue
up = 19 17 $ 2
s =

π
todry
s =$ 1840 %
v =
?
→
00 %
π down S =
$ 16
option ralue =$ 0

" "

Therefore ,
Up case :
portfowo ralne is π up =
δ L 9) ,
-

'
"
" portfo lio value is 5
D own Case
πdoun L 16 ) o
=
-

To make itrisk free , set π

up Tdown
=
,
δ [ 9),
-

2 =δ [ 163 ,

b =
号 ,
so that the
resusting portfo io values

match :
up : ×
219 -

2 =

: Ʃ× 16 =
2
Bown

Giventhat risk -

free rate is =
,firstodiscont the portfoliovalue π = T
3

EQ 09 × .
5
back
today " ody ⼆ 32 )
0

to
π ( ≈ 10 .
42934
 We know π to Slo ) ands determine
day ,
,
so we can the Current
option
value V
using tahe definition of
our
portfolio value π

.
V =≡× 18 10 42934
-

.
=
1 .

57066
fore tne rasue
Th t the hould be
h 1.
57006 ,whichis of option today $
presentho -arbitragevane of the
option ,

*
( b) U =
2 .
0 7 ichis the present Value ofthe
Uwh
option as 231 .
57066 .

cethas
This ,
means that the mar (
overpriced the call option ,
s0 the
strateqy
that will resuct in should be
profit
:
a

2
b =Ʃ
Firstly ,
ong
shares of Stock ;

Then ,
short one call option ;

Next ,
borrow cash =
C 2)S -

V
*
=☆ X 18 -
2
=

10 from the bomk at

risk free rate ( thismeans that we hare to

the
p backbanky
the with cash
.
og ×
of 10 × 回 ⾳ = 10 . 22755in 3 months
) .

Then at t =
3 lafter 3 months ) ,
seu the 5 shares of stock , pay tne bauk

back$ l 0 227 55 and off the option

pay
. .

2,
o If tne stock goes up f to $ . 19 , π t
up
= 69 -
=hand the value × 2
2

09 × 童
bepaidbact
0

]
-

cash needs to
pofit is π × e
-

up
0 09 × ⾔ 0 09 × ⾔
33 ) xe
.
.

( -

10 xe

09 × ⾔
3
歌 0
-

=
xe
_

10 × 1

=
$ 0 42934 .

2
,
Ifthe
Gtock
goesdo wn to $ 16 , Tidown =
16 x
2 =
anad the valne of the

0 09 × 最
profit is cash needsto
be paid back 2
.

$ (TIdown - a e

-
0 09 × ⾔ -

0.
09 ⾔ ×

)
.

=
[ ⾼
loxe xe

009 × ⾔
32
-

=
xe
_

10 × 1

=
$ 0 42934 .

∴ Thusthe Lalue of profitfor the option is $ 42934

0 .
.
 3
(a ) F[ x ,
t] = -

X sm ( t ] t 2 xet
'

then Fx =
-

3 sin ( t ] X + 2 et ; Ft = -

43 cos / t ) + 2 xet

and 6 x
x sm ( t )
-

=
,

since dx r ( Xit ) t ] dt LX ( t ) t) oad ,then Ito ' s Leamma

+σ
using
=
,

, ,
Ʃ

dF =
2 Fxd E + LMFx + FxX + FE ]dt andby
smbstitutionof Fxand Fxx and Ft ,

regetd ==σ . L -

3 s ,m (t
,
] x =+ 2 et ] az
?
x
3 sn (t 3 X + 2 et ] +Ʃ Xet } dt
2
+
(µ C C - bsM ( t . X - 3c ω s( t ) +2
,

-
]
,

+ ] 之

Thns , dF [ x t ]
=
( } -

sm ( t ) X 2 2 et , µ

(X (t ), ) + ( -6 S ,n ( t ] x,

} ·
Ʃ[ σ ( x ( t) E ] }

_
, t ,

et )
3
x ω s (t 3 + 2x et ] dt +σ (x1 t) t ) (
-

3 s , n (t 3 X
'
+ 2 dz
.
,

( b) mce dx =µ ( x ( t ) ,
t > at +σ ( x( t) ,
t) d 2 ,

2
' 2
then
S ( dx ) =
[ ( x ( t ) , ) dt +σ t
(
X ( t ), t ) dZ ] by substitntion ,

0 µ

Pdt =+ 》 da
2
=
r (x( t ) t ) ,
2 µ
[ x( t ), ) t
σ (
X ( t ), t ) dtdZ + ( σ ( X ( t) ,
t)

…
+σ≥ dZ
2 2

= r dt + 2
µ
,

σ
-

dtd 2 …
①
,

"

( af) as at → 0
05
since dn =
d Jdt = O ,
and odt d
= ) = O lat ) as dt → 0
,

then we continne with ① :

T ≤ 2
+σ≥
+

J 0
( dx } u
"dt ' 2 µ
,
σ

- dtdZ ,

dZ
2

( d +与 )
2
µ rdt
2 "
= + 2
U σ O +σ dZ
Again , apply ing Big - 0
Lassuming
smal at
, )

3 +σ^ dZ
2 2
dth
2

µ dt
2
U [
与

= + σ O

O ( at
" 5
y ' at as dt = daras dt→ o
)
=
+

= σ= dt

foTidx }
σ
0 P
=
Thus ,
S
x( t), ) dt (
t
.

'
 0
⼀

( a) Let X ( ti ] = X ; and Y( ti ) =
Yi

Then ( xi + 1
-

Xi ) ( Yi + 1
-

Yi ) =
Xi + 1 Yi + 1
-

Xi +
,
Yi -

XiYi + 1
+ XiYi
Yi *
xiYi xiYi Yi ++ xiY : - xiYi +
subracingxi :" xi * xi -

Smremameaaangand
-

=
+
,
(
f …

* (— 1 tx
xi ) ( xii ) aa - xiYi - + txiYi - *

Yinydistributive
Xit Yi XiYi Yi ( xi Xi ) xi ( Yi - aw
,
=

,
+ ,
- -

+ 1
-
-

+
1

by rearranging
=
Xi + iYi + 1 XiYi -

xi ( Yi + 1 -

Yi } -

Yi ( xi + 1
-

Xi )
-
,

Thus Yi Yi ) xi + iYi + - xi ( (Y ; -
'
we ve shown that ( xi + xi ) [ = - xi xis
(
xi + xi )
-

- i ,
-

1 +
1
+ 1
,

THen
using the
defmitionoftheIto integral which isthelimit of a dis crete sum ,

J tdx (
。
s ) dY ( s ) =

0
10 xicYi ,
where N =

t
Ʃ i =β

N 1 -

=um Ʃ ( Xi + 1
-

Xi ] ( Yi + 1 -

Yi] , as oXi =
Xi + 1 -

Xi and
ot → 0
i = 0
'
c Yi = Yi +
1
-

Yi ,

above conchusion make substitation ( Xi + 1 Xi ] [ Yi + ) Yi )

using the we
of
, a
-
-

N 1

( "[

Ʃ Xi + Xi ) ( Yi + 1 Yi )
靠 Xi + iYi+ XiYi Xi ( Yi Yi ) Yi ( Xi + - Xi )
]
- -

=
+ )
-

1
-
-

1 -
i =
0

声 iYi xiYi ⼀ xi ( Yi +
xi Yi ( Xi + 1 Xi )
⼀ ) ⼀声
^
→ ,

"

- Yi
-

+ +
1 →

〈 x
1 Y% + x2 Y2 + … × NYN ) (x
-

0 Y 0
+ x
1 Y0+
N
1
…

+ X ,N -

1 YN 〉 -

。1
-

⼀声 λ i ( Yi Yi
) Yi ( Xi + Xi )
-
-

+
。 ⼀
 x
XN 1YN
( xiY ,XNYN XN iYwi )
+ +
)+ X Y ( x 1Y, + +
-
-
…
=
0
-

1
- -

。1

⼀声 xi ( Yi Yi
⼀壶 Yi ( Xi + Xi )
)

-
-

+
^ 1 。

XNYN - 0
- xi ( Yi - Yi
⼀ Yi ( Xi + Xi )
)
%
=
×
-

Y
1

+
声

" 1 Yi
( Xi + - Xi …
x ( tN ) Y ( tN ] X (t ) Y (t )
。 xi ( Yi Yi
⼀
)… ①
)
-
-
= -

0 。
+
。

们 = xi0
=
i N
-

1 …

By 北筑管 y xi ( Yi + 1

) replaang the sum with an

integral xis ) dYis
」
=
Jot …
…

t 彦些
Ʃ* Yi
N

And Yi ( Xi + Xi ) Gm xi
similar
则
-

1
= -

0
,
ct → 0 「=0
→ 0

by replacing the sum mith an

integral ,
=
Jot Y( s) dx ( s ) … ③
…

Ʃ
1

Thenfotdx ( s ) dY ( s = ( xi Xi ) ( Yi -
- +

)
+ 1
t → 0
)0

" (

m
0
…
t
[a
limx tN ) tN - λ ( by
)Y 。
…

- xi ( Yi Yi ) Yi xi + =

< → o
( Y(
]

t
0 ( t
)

。
+
-
⼀

- Xi 0

tnenbycand <
③
t >0-
)… um × ( tN )Y ( N

) - ×( to 3 Y(
T -

Stx ( 。
s ] dY ( s ) -

Sot { ( s ) dx ( s )

Joty ( s )
t
= × Y
] 0
-

Sot λ ( s) dY < s )
-

dx ( s )

Joty ( s )
t
As fotdxls ) dY [ s ] =
[ XY J 0 -

Sot λ ( s) dY < s )
-

dX ( s ) ,
then fotx ( s) dY ( s ) =
[ XY ] 0
t -

fotY [ s ) dX ( s ) -

fotdX ( s ) d Y( s )
byrearranging
was
proven
.
 fying dz = d
satis , and assoum e [ )
Cb ] Let ICt ) be sto chastic process Tat 0 0
=

a
.

-
。
2
fotd 2 [ s
2
LHS = Sot ( s ) d 2 ( s) = [
Z [ s ] 2 [ s ] ] 。 t
J

t
[s ) d 2 (s ] - ) d 2 ls ) … brsshg the resust in (a)

) J Sotd 2)
t
=
2 ( t} 2 L 3
-

0
-

2 ( s ) d 2 ( s} -

( s
0

Jotdt
=
=
C (t) -

2 ( } 0
-

Sot 2 (s ) d 2 (s)
-

since in tthe limit as dt 30 we have that pdt

…
… -

becomes hon - s 7 ochastic , sothat d

23 9
→ t as dt s
-

fot 2 < ot
'
=Ʃ ( t3
-

0 -

s 3 da ( s3
-

[t ] …
-

since Ʃ [ ω) =
0
from asuomption .

= t
2( t )
f [ s ) d 2( ε
=
2 s]
-
-

fotr (
=
τnus
,
we
Get s) d 2 (s ) = 2 (t ) -

Sot 2( s ) d 2[ s)
-

Sot 2 (
2

) d 2[ s ] 2(t} t
rearranging gives : ≥ s = -

then1 1 .
t
2 ( s) d 2 ( s ) =Ʃ 2(t)
^
-

Ʃ
E
=Ʃ
R

Therefore ,
we
'
ve
proved that Sot 2 ( s ) d 2[ s ) 2 (t ) -