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MAT2094 Tutorial 4

The document contains a tutorial for MAT 2094 Derivative Securities II, focusing on various types of exotic options and their pricing using binomial trees and other financial models. It includes multiple questions that require calculations for Asian options, barrier options, European options, and their respective payoffs. Answers to the questions are provided at the end of the document.

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Shehan De Silva
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9 views5 pages

MAT2094 Tutorial 4

The document contains a tutorial for MAT 2094 Derivative Securities II, focusing on various types of exotic options and their pricing using binomial trees and other financial models. It includes multiple questions that require calculations for Asian options, barrier options, European options, and their respective payoffs. Answers to the questions are provided at the end of the document.

Uploaded by

Shehan De Silva
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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SCHOOL OF MATHEMATICAL SCIENCES

MAT 2094 DERIVATIVE SECURITIES II


(TUTORIAL 4A – EXOTIC OPTIONS I)

Question 1

You are given the following binomial tree for stock prices. Each period is one year.

A 2-year arithmetic annual average strike Asian call option on this stock is priced using the
binomial tree. The risk-free interest rate is 0.04 and the continuously compounded dividend yield
is 0.02. Determine the price of the option.

Question 2

An 8-month Asian average price call option based on the arithmetic average of monthly prices has
a strike price of 40. Prices at the end of each of the 8 months are 40, 42, 45, 42, 40, 35, 38, 40.
Determine the payoff of the option.

Question 3

A 5-month Asian average price put option based on the geometric average of monthly prices has
a strike price of 50. Prices at the end of each of the 5 months are 40, 42, 40, 30, 35. Determine the
payoff of the option.

Question 4

A 9-month Asian average price call option on a nondividend paying stock based on arithmetic
average of monthly prices is modeled with a 3-period binomial tree. The stock price is 49.5, the
strike price is 52, the tree has u = 1.1, d = 0.9, and the risk-free rate is 0.02. Calculate the risk-
neutral probability of an option payoff greater than 0.

MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies


SCHOOL OF MATHEMATICAL SCIENCES

Question 5

A down-and-in barrier call option has a barrier of 75 and a strike price of 85. The price of the
underlying stock is 90. The option is modeled with a 5-period binomial tree with u = 1.1 and
d = 0.9. Of the 32 possible paths, determine the number of paths having payoffs.

Question 6

The time-t price of a stock is S (t ). Given:

(i) S (0) = 80.


(ii) The stock pays a dividend of 2.50 at time 0.2.
(iii) The price of an up-and-out barrier call option with barrier 90, strike price 75, and expiring
at time 0.5 is 4.33.
(iv) The price of a European call option with strike price 75 expiring at time 0.5 is 8.51.
(v) The probability that the stock price hits the barrier by time 0.5 is 0.6.
(vi) The continuously compounded risk-free interest rate is 0.1.

Determine the price of an up-and-in put option with barrier 90, strike price 75, and expiring at time
0.5.

Question 7

At time t = 0, you have the following portfolio of options on a stock, all expiring in three years:

(i) An up-and-in barrier call option with barrier 70, strike price 50.
(ii) An up-and-out barrier call option with barrier 70, strike price 50.
(iii) An arithmetic average price Asian call option with strike price 50.

Each option’s payoff depends only on values of stock at the ends of years. The prices of the stock
at the ends of years are 55, 80, 55, and 60 for t = 0,1, 2,3, respectively. Determine the absolute
difference between the highest payout and the lowest payout of the three options.

MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies


SCHOOL OF MATHEMATICAL SCIENCES
Question 8

Let S (t ) be the price of a stock at time t. Given:

(i) S (0) = 45.


(ii) The stock pays dividend of 1 at the end of 2, 5, 8 and 11 months.
(iii) The continuously compounded risk-free interest rate is 0.06.
(iv) A 1-year European put option on the stock with strike price 40 costs 1.23.

Calculate the current value of a payment of max ( S (1), 40 ) at the end of a year.

Question 9

The pound/dollar exchange rate is assumed to follow the Black-Scholes framework. Given:

(i) The spot exchange rate is $2/£.


(ii) The continuously compounded risk-free interest for dollars is 0.03.
(iii) The continuously compounded risk-free interest for pounds is 0.05.
(iv) The volatility of the currency exchange rate is 0.08.

An agreement will pay you the maximum of $100 and £50 at the end of one year. Calculate the
value in dollars of this agreement to you.

Question 10

For a stock following the Black-Scholes framework, the current price of the stock is 50,
r = 0.04,  = 0.02, and  = 0.4. Let S (t ) be the price of the stock at time t. You are offered a
choice of two payments: either max ( 50, S (1) ) at the end of one year or c min ( 50, S (1) ) at the end
of one year. Determine c to make the current value of these payments equal.

Question 11

MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies


SCHOOL OF MATHEMATICAL SCIENCES

For a stock, you are given:

(i) The current price is 47.


(ii) r = 0.08.
(iii)  = 0.02.

Compound options with strike price 5.00 and 3-month expiry allow buying an option on the stock
expiring 1 year from now with a strike price of 50. The following are prices for three of the four
compound options:

Call Put
Call on… 1.796368 1.560035
Put on… 1.242242

Determine the price of the put-on-put option.

Question 12

For a European call-on-call option:

(i) The price of the underlying stock is 42.


(ii)  = 0.2.
(iii) The continuous annual dividend rate is 2%.
(iv) The continuously compounded risk-free interest rate is 6%.
(v) For the call-on-call option, the premium is 0.85, time to expiry is 3 months, and the strike
price is 4.
(vi) For the underlying call option, time to expiry is 6 months and the strike price is 40.
(vii) Options are priced using the Black-Scholes formula.

Determine the premium for European put-on-call option with the same underlying asset and strike
price.

MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies


SCHOOL OF MATHEMATICAL SCIENCES
Answers:

1. 1.2961

2. 0.25

3. 12.87

4. 0.406627

5. 1

6. 0.4556

7. 15

8. 42.36

9. 99.24

10. 1.377

11. 0.919429

12. 0.88

MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies

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