Scribd
Upload
685 views1 page

Financial Engineering Cheat Sheet

One page Financial Engineering Cheat Sheet. All formulas you need during your exam. Ito's lemma, Black-Scholes economy and all major formulas. basic maths also included. Symbols used are according to widely accepted standards.

Uploaded by

abnvahe
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
685 views1 page

Financial Engineering Cheat Sheet

One page Financial Engineering Cheat Sheet. All formulas you need during your exam. Ito's lemma, Black-Scholes economy and all major formulas. basic maths also included. Symbols used are according to widely accepted standards.

Uploaded by

abnvahe
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 1

Financial Engineering Cheat

Sheet
Basic Statistics / Probability
E[a +bX +cY ] = a +bE[X] +cE[Y ]
var(X) = E[X
2
] (E[X])
2
var(aX) = a
2
var(X)
var(aX +bY ) = a
2
var(X) +b
2
var(Y ) + 2abcov(X, Y )
cov(X, Y ) = E[XY ] E[X]E[Y ]
cov(a +bX, cY ) = cov(a, cY ) + cov(bX, cY ) = bccov(X, Y )

X,Y
=
cov(X,Y )

Y
Normal Distribution
f(x) =
1

2
e

(x)
2
2
2
Z =
X

P(Z z) =
1

2
R
z

x
2
2 dx
P(X x) = P(X x)
P( 2 X + 2) = P(2 Z 2) 95%
Lognormal Distribution
ln(Y ) N(,
2
)
E[Y ] = e
+

2
2
var(Y ) = e
2+
2
(e

2
+ 1)
Geometric Brownian Motion
dWtdt 0, dt
2
0, dW
2
t
dt
dXt = Xtdt +XtdWt
Xt = X0e
(

2
2
)t+Wt
n
ln Xt N(ln(X0) + (

2
2
)t,
2
t)
E[Xt] = X0e
t
,var(Xt) = X
2
0
e
2t
(e

2
t
1)
Continuous-Time Processes
dWt =

dt N(0, dt), E[dW


2
t
] = dt, var(dW
2
t
) = 0
Arithmetic Brownian Motion:
dXt = dt +dWt
Xt = X0 +t +Wt
E[Xt] = X0 +t , var(Xt) =
2
t
Ornstein-Uhlenbeck:
dXt = ( Xt)dt +dWt
Square Root Process:
dXt = ( Xt)dt +

XtdWt
It o Process:
Xt = X0 +
R
t
0
(Xs, s)ds +
R
t
0
(Xs, s)dWs
Itos Lemma
df =
f
Xt
dXt +
f
t
dt +
1
2

2
X
2
t
(dXt)
2
Ito Product Rule
d(ftgt) = ft
h
g
X
dX +
g
t
dt +
1
2

2
X
2
(dX
2
)
i
+
h
g
X
dX +
g
t
dt +
1
2

2
X
2
(dX
2
)
i
+
f
X
g
X
(dX)
2
Black-Scholes Economy
dBt = rBtdt Bt = B0e
rt
dSt = Stdt +StdWt St = S0e
(

2
2
)t+Wt
t = tBt +tSt dt = t[rBtdt] +t[Stdt +StdWt]
t =
V
St
, t =
1
rBt

V
t
+
1
2

2
S
2
t

2
V
S
2
t

1
{S
T
K}
= N(d2), d2 =
ln
S
t
K
+(r

2
2
)(Tt)

Tt
Black-Scholes PDE
V
t
+
1
2

2
S
2
2
V
S
2
+rS
V
S
rV = 0
with boundary condition V (S
T
, T) = f(S
T
)
Normalized Security Prices
d

1
Bt

=
r
Bt
dt
d

St
Bt

=
St
Bt
h
Wt +
r

t
i
=
St
Bt
dW

t
Under P

: dSt = rStdt +StdW

t
, W

t = Wt +
r

Remember that Wt N(
r

t, t) , W

t
N(0, t)
Derivative price process:
Vt = Bt +tSt dVt = rVtdt +t( r)Stdt +tStdWt
Normalized derivative price process (by product rule):
d

Vt
Bt

=
1
Bt
dVt +Vtd
1
Bt
+dVtd
1
Bt
= t
St
Bt
dW

t
Hence dVt = rVtdt +tStdW

t
Non-traded dynamics: dXt = [ ]dt +dW

t
Traded dynamics: dSt = rStdt +StdW

t
S
T
= Ste
(r
1
2

2
)(Tt)+(W

T
W

t
)
S
T
= Ste
(r
1
2

2
)(Tt)+z

Tt
, z =
W

T
W

Tt
ln S
T
N(ln S
T
+ (r
1
2

2
)(T t),
2
(T t))
Income at rate q: dS = (r q)Sdt +SdWt
Fundamental Theorem of Asset Pricing
Vt
Bt
= E

t
h
V
T
B
T
i
Market Price Of Risk
For an economy with a single source of uncertainty:
Sharpe Ratio:
1r
1

2r
2
=
Proof : construct riskless portfolio
d = dBt +dS1 +2dS2
1S1 +22S2 = 0, B +S1 +2S2 = 0, d > 0, arb.
Non-Traded Asset Derivative PDE
V
t
+
1
2

2
2
V
X
2
+ ( )
V
X
rV = 0
Traded Asset Derivative PDE
V
t
+
1
2

2
S
2
2
V
S
2
+rS
V
S
rV = 0
Multidimensional Itos Lemma
df(X, Y, t) =
f
X
dX +
f
Y
dY +
f
d
dt +
1
2

2
f
X
2
(dX)
2
+
1
2

2
f
Y
2
(dY )
2
+

2
f
XY
dXdY
Derivative PDE on Two Securities
V
t
+
1
2

2
S
2
1

2
V
S
2
1
+
1
2

2
S
2
2

2
V
S
2
2
+12S1S2

2
V
S1S2
+
rS1
V
S1
+rS2
V
S2
rV = 0
Exotics
Quantos:
Use two-security derivative where S1=$/, S2 = , B=$
S1 (r r
f
), S2 (r
f
12)
Binary Options:
Call:Vt = e
r(Tt)
P

(S
T
K) = e
r(Tt)
N(d2)
Put:Vt = e
r(Tt)
(1 N(d2)) = e
r(Tt)
N(d2)
Chooser:
Vt = Ct(K, T

) +Pt(Ke
(Tt)
, T)
Asian Options:
Avg. Strike/Price Call: max[S
T


S
T
, 0]/[

S
T
K, 0]
Arithmetic/Geometric:
1
T
R
T
0
Stdt/ exp

1
T
R
T
0
ln(St)dt

Term Structure Modelling


r(t, T) =
1
(Tt)
ln e
r
t,T
(Tt)
f(t, T1, T2) =
ln B(t,T2)ln B(t,T1)
T2T1
Vasicek Model: drt = a(b rt)dt +sW

t
Cox-Ingersoll-Ross: drt = a(b rt)dt +

rtdW

t
Hull-White: drt = a

b(t)
a
rt

dt +dW

t
Heath-Jarrow-Morton:
dB(t, T) = rtB(t, T)dt +
B
(t, T)B(t, T)dW

t
Market Risk Measurement
t =

(Xt) +
1
2

(Xt)
2
+

t
VaR Quantile: = q = N
1
(1 c)
c 2007 Rory Winston <roryresearchkitchen.co.uk>

You might also like