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Derivative Securities

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Derivative Securities

Tutorial Questions

Option pricing using Simulation Techniques

QUESTION 1

This question refers to the VBA program “Monte Carlo European Option.xlsm” as well as the option discussed in lectures (details repeated as follows)

Stock price is currently traded at $1.76. Calculate the price of a European call (strike $1.60, maturity 3 months) on one share. Assume risk free rate of 10% p.a., stock price volatility is 30% p.a. and company not expected to pay any dividends over the next 3 months

a) Briefly explain the methodology used to value the European call and put.

b) Explain how you would modify the code to price an Asian option.

c) Approximate the rho by changing the risk free rate to 9%. Compare this to that from the BSM model where [pic].

d) Now assume a dividend yield of 2% p.a payable over the life of the option. Re-price the option (with risk free rate at 10%). Is the price consistent with your expectations? Why/why not?

e) Describe how you could modify the code to allow for leptokurtosis (fat tails).

QUESTION 2

Describe how you could use a simulation to price an option using the binomial tree approach.

QUESTION 3

Describe the difference between a bootstrap and a monte carlo simulation. Discuss one advantage and disadvantage of the monte carlo approach.

QUESTION 4
A Public–private partnership (PPP) describes a government service or private business venture which is funded and operated through a partnership of government and one or more private sector companies. The PPP involves a contract between a public-sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project.
Consider a PPP for a toll road, where the government receives a share of the toll road...

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