Dartmouth College, Fall 2017

Mathematical Finance I, Math 86 S. Nanda

Assignment 1 Due: Sept 20,2017 in class

You may discuss the problems and solutions with anyone but the work written up and
submitted must be done on your own. Justify every step.

1. A one year forward contract on a non-dividend paying stock is entered into when the
stock price is $40 and the risk-free rate of interest is 2% per annum - semi-annual
compounding. What is the forward price? What is the initial value of the forward
contract? Six months into the contract the stock price is at $35. The risk-free rate is
the same. What is the forward price? What is the value of the forward contract at six
months?

2. Suppose you own 4000 shares worth $25 each. How can put options be used to provide
you insurance against a decline in the value of your holding over the next 4 months?

3. The price of gold is currently $500 per ounce. The forward price for delivery in one
year is $700. An arbitrageur can borrow money at 10% per annum. What should the
arbitrageur do? Assume the cost of storing gold is zero.

4. Prove the following: Theorem: Consider Portfolios A and B. If A and B are such that
at every possible state of the market at time T, Value(A) ≥ Value(B) then at any time
t < T Value(A) ≥ Value(B). If in addition Value(A) > Value(B) in some states of the
market, then at any time t < T , Value(A) > Value(B). Hint: go long A and short B.
Work with this portfolio and no arbitrage arguments

5. (a) Prove the lower bounds on price c or p of a plain vanilla call or put respectively,
on non-dividend paying stock. That is, given a European call struck at K and a
European put struck at X, both with expiration T, show that c > S − Ke−r(T −t)
and p > Xe−r(T −t) − S. S is spot price of stock.
(b) What is the lower bound for the price of a one-month call option on a non-dividend
paying stock, when the stock price is 30, the strike is 25, and risk-free interest
rate is 8%.

6. Assume interest rates are zero. Show that if call option prices are a differentiable
function of the strike price, then differentiating the price with respect to the strike
must give a value ∈ (−1, 0). What if interest rates are not zero?

7. An asset is worth 200 today and has constant value in the future, except at random
times when the asset’s value drops by a random amount. Construct an arbitrage.