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Simulation Tutorial Questions

This document contains 6 questions regarding the valuation of various derivative securities using Monte Carlo simulation techniques. The questions cover topics such as: 1) Explaining the methodology to value European call and put options via simulation and how the code would be modified to value Asian options. 2) Using simulation to price options via the binomial tree approach. 3) Comparing bootstrap and Monte Carlo simulations and discussing their advantages and disadvantages. 4) Using simulation to value a government asset from a public-private partnership for a toll road. 5) Outlining how simulation could be used to price a European basket call option. 6) Comparing simulated and Black-Scholes prices for a European call

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Claudia Choi
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35 views

Simulation Tutorial Questions

This document contains 6 questions regarding the valuation of various derivative securities using Monte Carlo simulation techniques. The questions cover topics such as: 1) Explaining the methodology to value European call and put options via simulation and how the code would be modified to value Asian options. 2) Using simulation to price options via the binomial tree approach. 3) Comparing bootstrap and Monte Carlo simulations and discussing their advantages and disadvantages. 4) Using simulation to value a government asset from a public-private partnership for a toll road. 5) Outlining how simulation could be used to price a European basket call option. 6) Comparing simulated and Black-Scholes prices for a European call

Uploaded by

Claudia Choi
Copyright
© © All Rights Reserved
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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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 .

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
revenue only if a certain revenue threshold is exceeded. Explain how one might use a
monte carlo simulation to value the government’s asset.

QUESTION 5

Assume you are seeking to price a European basket call option whose underlying
asset is a group of stocks denoted in the same currency. Here the holder has the right,
but not the obligation, to buy the group of underlying assets.

a) Briefly explain why you cannot use the BSM model to price this exotic option
b) If you were seeking to price this option via monte carlo simulation, briefly
outline how you would go about this.

QUESTION 6

This question requires you to price the European call option on the S&P500 examined
in the Dividends tutorial - Question 8. Recall the valuation is as at the close of trade
on October 30, 2017. The option has the following characteristics
- Maturity date Dec 15, 2017
- Strike 2575
- Vol 8.7246%
- Other parameters as before
a) Discretise the underlying into daily price increments and employ 10,000
sample paths. How does the price compare to the BSM price?
b) Set up a spreadsheet to calculate the simulated distribution of S&P500 index
values as at the maturity date. Use the above parameter values with daily price
increments. Consider 1000 sample paths.
c) Plot the histogram of the distribution in part b) and calculate its skewness.
Comment.
d) Re-perform parts b) and c) using a volatility of 25%. Comment

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