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Assignment1 FunTry
Assignment1 FunTry
AMOD
Homework #1
Student name:
Question 1
(c) [3] Find the expected value and variance of X (if they exist).
1
AMOD 5520H: Mathematical Finance – Homework #1 2
Question 2
Suppose that a particular trait of a person (such as eye colour or left handedness) is
classified on the basis of one pair of genes and suppose that d represents the domi-
nant gene and r a recessive gene. Thus a person with dd genes is pure dominance,
one with rr is pure recessive, and one with rd is hybrid. The pure dominance and the
hybrid are alike in appearance. Children receive one gene from each parent. If, with
respect to a particular trait, two hybrid parents have a total of four children, what is
the probability that exactly three of the four children have the outward appearance
of the dominant gene? (Make sure to explain your reasoning and any assumptions you
have made.)
Question 3
In rural Ireland, a century ago, the students had to form a line. The student at the
front of the line would be asked to spell a word. If he spelled it correctly, he was
allowed to sit down. If not, he received a whack on the hand with a switch and was
sent to the end of the line. Suppose that a student could spell correctly 70% of the
words in the lesson. What is the probability that the student would be able to sit
down before receiving four whacks on the hand? Assume that the master chose the
words to be spelled randomly and independently.
Question 4
Question 5
Suppose that c1 , c2 , and c3 are the prices of European call options with strike prices
K1 , K2 , and K3 , respectively, where K3 > K2 > K1 and K3 − K2 = K2 − K1 . All options
have the same maturity. Show that
c2 ≤ 0.5(c1 + c3 ) (1)
(Hint: Consider a portfolio that is long one option with strike price K1, long one
option with strike price K3, and short two options with strike price K2.)
Question 6
Question 7
Question 8
(b) What is the value of a 6-month American put option with a strike price of $42?
Question 9 - Extension
An up-and-out barrier option is a type of option that works much like a European
Call option. However, if the stock price gets larger than a certain set barrier value,
the payout becomes zero. A binomial Tree can be used to price this type of exotic
option as well.
Question 10 - Extension
Another type of model that can be used to price options is the Trinomial Tree. In
the Trinomial tree there are three options for the price of the underlying stock in the
future. The stock can go up at rate u, down with rate d, or remain the same with rate
of m = 1 − u − d. In order to be a recombining tree is necessary for u = 1/d. Note on
each step there are three branches up, down, no change and on each time step there
are two additional nodes created.