FINANCIAL MATHEMATICS

Resit – 14.07.2022 – 9:00-12:00

All documents (including books and notes) and electronic devices (including calculator, tablets, mobile phones, comput-
ers, smart watches, and so on) are forbidden. Answers to the questions and all computations must be carefully justified
by mathematical arguments. Please use the name of any theorem or result when applying it.

Exercise 1 (20 points)

State Itô’s isometry for simple processes and give a detailed proof of it.

Exercise 2 (20 points)

State Girsanov’s theorem for Brownian motion and give a detailed proof of it using the general Girsanov’s theorem.

Exercise 3 (40 points)

Let St be a stock that pays dividends continuously at the rate At . It is modelled as

dSt = St (αt dt + σt dWt − At dt), (1)

where αt , At and σt are positive adapted processes and Wt is a P standard Brownian motion.
1. Interpret αt and σt .
Rt

2. Let Xt be the value of a self-financing portfolio invested in stock St and bond Bt := exp 0 Rt dt . The number
∆t of shares of stock and the interest rate Rt are assumed to be both adapted processes. Moreover, ∆t is assumed
to be predictable.

Show that Xt satisfies

dXt = ∆t dSt + ∆t At St dt + Rt (Xt − ∆t St )dt. (2)

3. Show that

dXt = Rt Xt dt + ∆t St σt (Θt dt + dWt ). (3)

where Θt := (αt − Rt )/σt . How do you interpret Θt ?

f := W + · Θ(u)du is a Brownian motion. Which stochastic differential equation
R
4. Find a measure P
e under which W
0
in terms of W
f does the process X satisfy under P?
e

5. In this question, αt =: α, Rt =: r, σt =: σ and At =: a are supposed to be deterministic and constant. Compute

the price of a European call expiring at a time T > 0 with a strike K > 0. How do you interpret it?

Exercise 4 (20 points) Rx

In this exercise, W is a standard Brownian motion. Denote Φ(x) := −∞ exp(−u2 )du. Compute the following stochas-
tic integrals:
Rt
1. 0 exp(−Wu2 )dWu .
Rt
2. 0 u2 Wu cos(Wu2 )dWu .
Rt
3. 0 Wu (1 + u2 )−1 dWu .
Rt
4. 0 Wu cos(uWu )dWu .
Rt
5. 0 Wu Bu dWu where B is another Brownian motion independent of W .

Duration 3 hours