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Assignment 1

The document is an assignment from the Department of Mathematics at Visvesvaraya National Institute of Technology, Nagpur, focusing on financial mathematics topics such as the time value of money and replication strategies. It includes various problems related to bond returns, arbitrage opportunities, loan calculations, risk-neutral probabilities, and option pricing. The assignment aims to enhance understanding of financial concepts and their practical applications.

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Anurag Yadav
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6 views1 page

Assignment 1

The document is an assignment from the Department of Mathematics at Visvesvaraya National Institute of Technology, Nagpur, focusing on financial mathematics topics such as the time value of money and replication strategies. It includes various problems related to bond returns, arbitrage opportunities, loan calculations, risk-neutral probabilities, and option pricing. The assignment aims to enhance understanding of financial concepts and their practical applications.

Uploaded by

Anurag Yadav
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
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Visvesvaraya National Institute of Technology, Nagpur

Department of Mathematics
Assignment (Time value of Money, Replication Strategy)
Financial Mathematics

1. After how many days will a bond purchased for B(0, 1) = Rs. 0.92 produces a 5% return?

2. Spot an arbitrage opportunity (if it exists) in the following situation. Suppose that a dealer A
offers to buy British pounds in an year from now at a rate of Rs. 79 a pound, while dealer B
would sell British pounds immediately at a rate of Rs. 80 a pound. Assume that a rupee can be
borrowed at an annual rate of 4% and a British pound can be invested in a bank at 6% annual
interest.

3. Assume that that a person can afford to pay Rs. 10, 000 at the end of each year. How much the
person can borrow if the interest rate is 12% and he/she wishes to clear the loan in 5 years?

4. How long will it take for a sum of $ 800 attracting simple interest to become $ 830 if the rate is
9%. Compute the return on this investment.

5. Which is greater, the interest rate r or the return K(0, 1) if the compounding frequency m is
greater than 1?

6. What is the present value of an annuity consisting of monthly payments of an amount C contin-
uing for n years? Express the answer in terms of the effective rate re .

7. A stock is worth Rs. 50 today. Interest rates are zero. It is worth Rs. 40 or Rs. 70 tomorrow.
What risk-neutral probabilities should be used to price an option?

8. Suppose A is worth Rs. 100 today and worth Rs. 90 or Rs. 110 tomorrow. Asset B is worth
Rs. 100 today and worth Rs. 80 or Rs. 120 tomorrow. Asset B is worth Rs. 80 if and only if A
is worth Rs. 90. There is no riskless bond. Price a call option on A with strike price at Rs. 100.

9. A certain stock is selling for Rs. 50. The feeling is that for each month, for the next two months,
the stock price will rise by 10% or fall by 10%. Assuming that the risk free rate is 1%, calculate
the price of the European call with the strike price of Rs. 48.

10. Let S(0) = 120, u = 1.2, d = 0.9 and r = 1%. Consider a call option with strike price K = 120
and T = 2. Find the option price and the replicating strategy.

11. What will be the difference between the value after 1 year of Rs. 10, 000 deposited at 10% com-
pounded monthly and compounded continuously. How frequently should the periodic com-
pounding be done for the difference to be less than Rs. 1.

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