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Mod 4 Exam Jan 16

1. The document provides instructions for an examination on quantitative finance concepts. It contains 5 questions testing understanding of short rate models, bond pricing, stochastic processes, and LIBOR market models. Full working and explanations are required. 2. Question 1 asks to derive the price of a floorlet using the Vasicek model. Question 2 requires writing the Black-Derman-Toy model in Itô form. Question 3 involves solving the bond pricing PDE for the extended Hull-White model. 3. Questions 4 and 5 involve stochastic processes, with question 5 requiring use of a LIBOR market model spreadsheet to price a caplet using Monte Carlo with and without antithetic variates. Convergence diagrams and

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372 views2 pages

Mod 4 Exam Jan 16

1. The document provides instructions for an examination on quantitative finance concepts. It contains 5 questions testing understanding of short rate models, bond pricing, stochastic processes, and LIBOR market models. Full working and explanations are required. 2. Question 1 asks to derive the price of a floorlet using the Vasicek model. Question 2 requires writing the Black-Derman-Toy model in Itô form. Question 3 involves solving the bond pricing PDE for the extended Hull-White model. 3. Questions 4 and 5 involve stochastic processes, with question 5 requiring use of a LIBOR market model spreadsheet to price a caplet using Monte Carlo with and without antithetic variates. Convergence diagrams and

Uploaded by

pallab2110
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CQF Module 4 Examination

January 2016 Cohort


Instructions
All questions must be attempted. Books and lecture notes may be referred to. Spreadsheets and VBA (or
other recognised programing language) may be used.
Any queries should be e-mailed to riaz.ahmad@…tchlearning.com for questions 1-4 (only) and
richard.diamond@…tchlearning.com for question 5
dW is the usual increment of a Brownian motion.

1. We wish to …nd the approximate value of a cash‡ow for a ‡oorlet on the one month LIBOR, when
using the Vasicek model. Show that this is given by
1
max rf r 24
( r) ; 0 ;
where rf is the ‡oor rate and r the spot rate. [10 Marks] You must start by considering the
yield curve power series expression given in the calibration and data analysis lecture.
Full working should be given for the series expansion.
2. Consider the Black-Derman & Toy (BDT) short-rate model given by
d (log (t))
d (log r) = (t) + log r dt + (t) dW:
dt
Using Itô, write down the BDT model as
dr = A (r; t) dt + B (r; t) dW:
[5 Marks]
3. Consider the spot rate r, which evolves according to the SDE
dr = u (r; t) dt + w (r; t) dW:
The extended Hull and White model has drift and di¤usion
u (r; t) = (t) r; w (r; t) = c;
in turn, where (t) is an arbitrary function of time t and and c are constants. Deduce that the
value of a zero coupon bond, Z (r; t ; T ) which has
Z (r; T ; T ) = 1
in the extended Hull and White model is given by
Z (r; t ; T ) = exp (A (t; T ) rB (t; T )) ;
where
1
B (t ; T ) = 1 e (T t)
Z T
c2 2 (T t) 1 2 (T t) 3
A (t; T ) = ( )B ( ;T) d + 2 (T t) + e e :
t 2 2 2
[8 Marks] Note: You are required to solve the Bond Pricing Equation for this model.

1
4. Consider the process given by

dUt = Ut dt + dWt ; U0 = u;

where ; are constants. Solve this equation for Ut and hence obtain the expectation E [Ut ] and
variance V [Ut ] : [12 Marks]

5. HJM model evolves the whole forward curve. To obtain an expectation of LIBOR rate in the future,
Forward LIBOR L(t; Ti ; Ti+1 ), select the rate from corresponding tenor column = Ti+1 Ti of the
HJM output, from the correct simulated time (future curves are in rows). Convert to the simple
annualised rate using L = m ef =m 1 where m is compounding frequency per year.

Forward LIBOR re-sets (expires) at Ti and matures (paid on some cash‡ow) at Ti+1 . This future
payment has to be discounted.

Use the HJM Model - MC.xlsm spreadsheet from the HJM Model Lecture in order to price a caplet
option written on 6M LIBOR starting six months from today:

DFOIS (0; 1) max (L(0; 0:5; 1) K; 0) N

with the following parameters K = 3:5%, N = 100; 000, as follows from the task, and
DFOIS (0; 1) = 0:996, a discount factor taken from a curve built from traded OIS swaps. [35 Marks]

To satisfy the risk-neutral expectation conduct Monte-Carlo with and without the use of antithetic
variance reduction technique.

Two convergence diagrams must be provided together with a brief error analysis.
Forward LIBOR from the given forward curve calculation examples are in Yield Curve v2.xlsm
An annotated caplet payo¤ calculation is given on Caplet tab in HJM Model - MC.xlsm

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