MatLab For Financial Engineers

Workshop 1 - Introduction

Stefano Corradin & Peng Liu

Masters in Financial Engineering
University of California, Berkeley
March, 2006

MatLab Workshop 1-1

Introduction:
 Peng Liu: [email protected] (1)
 Stefano Corradin: [email protected] (2-4)

 The MathWorks documentation page

http://www.mathworks.com/access/helpdesk/help/helpdesk.html

Download Materials:
http://faculty.haas.berkeley.edu/peliu/
computing

Stefano Corradin
MatLab Workshop 1-2 Peng Liu
What is MatLab?
 What is MATLAB ?
 MATLAB is a computer program that combines computation and
visualization power that makes it particularly useful for engineers.
 MATLAB is an executive program, and a script can be made with
a list of MATLAB commands like other programming language.
 MATLAB Stands for MATrix LABoratory.
 The system was designed to make matrix computation particularly
easy.
 The MATLAB environment allows the user to:
 manage variables
 import and export data
 perform calculations
 generate plots
 develop and manage files for use with MATLAB.

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MatLab Workshop 1-3 Peng Liu
 MATLAB Environment

To start MATLAB:
START  PROGRAMS
 PhD & MFE
Applications 
MATLAB 7.1

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MatLab Workshop 1-4 Peng Liu
Display Windows

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MatLab Workshop 1-5 Peng Liu
 Display Windows (con’t…)
 Graphic (Figure) Window
 Displays plots and graphs
 Created in response to graphics commands.

 M-file editor/debugger window

 Create and edit scripts of commands called M-
files.

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MatLab Workshop 1-6 Peng Liu
Getting Help
 type one of following commands in the
command window:
 help – lists all the help topic
 help topic – provides help for the specified topic
 help command – provides help for the specified command
 help help – provides information on use of the help command
 helpwin – opens a separate help window for navigation
 lookfor keyword – Search all M-files for keyword
 Google “MATLAB helpdesk”
 Go to the online HelpDesk provided by
www.mathworks.com

Stefano Corradin
MatLab Workshop 1-7 Peng Liu
Variables
 Variable names:
 Must start with a letter
 May contain only letters, digits, and the underscore “_”
 Matlab is case sensitive, i.e. one & OnE are different variables.
 Matlab only recognizes the first 31 characters in a variable name.
 Assignment statement:
 Variable = number;
 Variable = expression;
 Example:
>> A = 1234; NOTE: when a semi-
>> a = 1234
colon ”;” is placed at
a=
1234 the end of each
command, the result is
not displayed.
Stefano Corradin
MatLab Workshop 1-8 Peng Liu
Variables (con’t…)
 Special variables:
 ans : default variable name for the result
 pi: π = 3.1415926…………
 eps: ∈ = 2.2204e-016, smallest amount by which 2 numbers can differ.
 Inf or inf : ∞, infinity
 NaN or nan: not-a-number
 Commands involving variables:
 who: lists the names of defined variables
 whos: lists the names and sizes of defined variables
 clear: clears all varialbes, reset the default values of special
variables.
 clear name: clears the variable name
 clc: clears the command window
 clf: clears the current figure and the graph window.

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MatLab Workshop 1-9 Peng Liu
Vectors, Matrices and Linear Algebra

 Vectors
 Array Operations
 Matrices
 Solutions to Systems of Linear Equations.

Stefano Corradin
MatLab Workshop 1-10 Peng Liu
Vectors
 A row vector in MATLAB can be created by an explicit list, starting with a left bracket,
entering the values separated by spaces (or commas) and closing the vector with a right
bracket.
 A column vector can be created the same way, and the rows are separated by semicolons.
 To input a matrix, you basically define a variable. For a matrix the form is:

variable name = [#, #, #; #, #, #; #, #, #;…..]

1st row 2nd row 3rd row
 Example: x is a row vector.
>> x = [ 0 0.25*pi 0.5*pi 0.75*pi pi ]
x=
0 0.7854 1.5708 2.3562 3.1416
>> y = [ 0; 0.25*pi; 0.5*pi; 0.75*pi; pi ]
y= y is a column vector.
0
0.7854
1.5708
2.3562
3.1416

Stefano Corradin
MatLab Workshop 1-11 Peng Liu
Vectors (con’t…)

 Vector Addressing – A vector element is addressed in MATLAB with an integer

index enclosed in parentheses.
 Example:
>> x(3)
ans =
1.5708 3rd element of vector
x
The colon notation may be used to address a block of elements.
(start : increment : end)
start is the starting index, increment is the amount to add to each successive index, and end
is the ending index. A shortened format (start : end) may be used if increment is 1.
Example:
>> x(1:3)
ans =
0 0.7854  1st to 3rd elements of vector
1.5708
NOTE: x
MATLAB index starts at 1.
Stefano Corradin
MatLab Workshop 1-12 Peng Liu
Vectors (con’t…)
Some useful
commands:
x = start:end create row vector x starting with start, counting by
one, ending at end

x = start:increment:end create row vector x starting with start, counting by

increment, ending at or before end
linspace(start,end,number) create row vector x starting with start, ending at
end, having number elements
length(x) returns the length of vector x

y = x’ transpose of vector x

dot (x, y) returns the scalar dot product of the vector x and y.

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MatLab Workshop 1-13 Peng Liu
Array Operations
Scalar-Array Mathematics

For addition, subtraction, multiplication, and division of an array by

a scalar simply apply the operations to all elements of the array.

Example:
>> f = [ 1 2; 3 4]
f=
1 2
3 4 Each element in the array f is
>> g = 2*f – 1 multiplied by 2, then
g= subtracted by 1.
1 3
5 7

Stefano Corradin
MatLab Workshop 1-14 Peng Liu
Array Operations (con’t…)
 Element-by-Element Array-Array Mathematics.

Operation Algebraic Form MATLAB

Addition a+b a+b

Subtraction a–b a–b
Multiplication axb a .* b
Division a÷b a ./ b
Exponentiation ab a .^ b

 Example:
>> x = [ 1 2 3 ];
>> y = [ 4 5 6 ];
Each element in x is
>> z = x .* y multiplied by the
z=
4 10 18
corresponding element in y.
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MatLab Workshop 1-15 Peng Liu
Matrices
 A Matrix array is two-dimensional, having both multiple rows and multiple columns,
similar to vector arrays:
 it begins with [, and end with ]
 spaces or commas are used to separate elements in a row
 semicolon or enter is used to separate rows.

A is an m x n matrix.
•Example:
>> f = [ 1 2 3; 4 5 6]
f=
1 2 3
4 5 6
>> h = [ 2 4 6
1 3 5]
h=
2 4 6
the main 1 3 5
diagonal
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MatLab Workshop 1-16 Peng Liu
Matrices (con’t…)
 Matrix Addressing:
-- matrixname(row, column)
-- colon may be used in place of a row or column reference to select
the entire row or column.

 Example:
recall:
>> f(2,3) f=
ans = 1 2 3
6 4 5 6
>> h(:,1) h=
ans = 2 4 6
1 3 5
2
1
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MatLab Workshop 1-17 Peng Liu
Matrices (con’t…)

Some useful
commands:
zeros(n) returns a n x n matrix of zeros
zeros(m,n) returns a m x n matrix of zeros

ones(n) returns a n x n matrix of ones

ones(m,n) returns a m x n matrix of ones

size (A) for a m x n matrix A, returns the row vector

[m,n] containing the number of rows and
columns in matrix.

length(A) returns the larger of the number of rows or

columns in A.

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MatLab Workshop 1-18 Peng Liu
Matrices (con’t…)
more
Transpose Bcommands
= A’
Identity Matrix eye(n)  returns an n x n identity matrix
eye(m,n)  returns an m x n matrix with ones on the main
diagonal and zeros elsewhere.
Addition and subtraction C=A+B
C=A–B
Scalar Multiplication B = αA, where α is a scalar.
Matrix Multiplication C = A*B
Matrix Inverse B = inv(A), A must be a square matrix in this case.
rank (A)  returns the rank of the matrix A.
Matrix Powers B = A.^2  squares each element in the matrix
C = A * A  computes A*A, and A must be a square matrix.
Determinant det (A), and A must be a square matrix.
A, B, C are matrices, and m, n, α are
scalars.
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MatLab Workshop 1-19 Peng Liu
Solutions to Systems of Linear Equations
 Example: a system of 3 linear equations with 3 unknowns (x1, x2, x3):
3x1 + 2x2 – x3 = 10
-x1 + 3x2 + 2x3 = 5
x1 – x2 – x3 = -1

Let :
 3 2 − 1  x1  10 
A = − 1 3 2  x =  x2  b= 5 
   
 1 − 1 − 1
 x3  − 1

Then, the system can be described as:

Ax = b

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MatLab Workshop 1-20 Peng Liu
Solutions to Systems of Linear Equations
(con’t…)
 Solution by Matrix Inverse:  Solution by Matrix Division:
Ax = b The solution to the equation
A-1Ax = A-1b Ax = b
x = A-1b can be computed using left division.
 MATLAB:  MATLAB:
>> A = [ 3 2 -1; -1 3 2; 1 -1 -1]; >> A = [ 3 2 -1; -1 3 2; 1 -1 -1];
>> b = [ 10; 5; -1]; >> b = [ 10; 5; -1];
>> x = inv(A)*b >> x = A\b
x= x=
-2.0000 -2.0000
5.0000 5.0000
-6.0000 -6.0000
Answer: Answer:
x1 = -2, x2 = 5, x3 = -6 x1 = -2, x2 = 5, x3 = -6
NOTE:
left division: A\b  b ÷ A right division: x/y  x ÷ y
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MatLab Workshop 1-21 Peng Liu
Plotting in Matlab
 Goal:plot y = sin(x)
 Matlab code
xplot = (0 : 0.01 : 2)*pi;

yplot = sin(xplot);
plot(xplot, yplot)

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MatLab Workshop 1-22 Peng Liu
Plotting in Matlab (cont.)
1

0.8

0.6

0.4

0.2

­0.2

­0.4

­0.6

­0.8

­1
0 1 2 3 4 5 6 7

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MatLab Workshop 1-23 Peng Liu
Plotting points
xpts = (0 : 0.1 : 2)*pi; % 21 evenly spaced points
ypts = sin(xpts);
1
plot(xpts, ypts, '+')
0.8

0.6

0.4

0.2

­0.2

­0.4
Type help plot to see ­0.6
point specification options ­0.8
in addition to '+' ­1
0 1 2 3 4 5 6 7

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MatLab Workshop 1-24 Peng Liu
Plotting more than one thing
 Option 1: inside one plot command
plot(xplot, yplot, xpts, ypts, 'o')
1

0.8

0.6

0.4

0.2

­0.2

­0.4

­0.6

­0.8

­1
0 1 2 3 4 5 6 7

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MatLab Workshop 1-25 Peng Liu
Plotting more than one thing

 Option 2: using hold on, hold

off 1

Add plot of y = cos(2x) 0.8

0.6

0.4

yplot2 = cos(2*xplot); 0.2

hold on 0

plot(xplot, yplot) ­0.2

plot(xpts, ypts, 'o') ­0.4

plot(xplot, yplot2) ­0.6

hold off ­0.8

­1
0 1 2 3 4 5 6 7

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MatLab Workshop 1-26 Peng Liu
Adding color to plots
clf
xplot = (0 : 0.01 : 2)*pi;
yplot = sin(xplot);

xpts = (0 : 0.1 : 2)*pi;

ypts = sin(xpts);

yplot2 = cos(2 * xplot);

hold on
plot(xplot, yplot, 'r') % y = sin(x), red line
plot(xpts, ypts, 'ko') % y = sin(x), black circles
plot(xplot, yplot2, 'g') % y = cos(2x), green line
hold off
Type help plot to see color options
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MatLab Workshop 1-27 Peng Liu
Plotting (con’t…)
 Plotting Curves:
 plot (x,y) – generates a linear plot of the values of x (horizontal axis) and y (vertical axis).
 semilogx (x,y) – generate a plot of the values of x and y using a logarithmic scale for x and a
linear scale for y
 semilogy (x,y) – generate a plot of the values of x and y using a linear scale for x and a
logarithmic scale for y.
 loglog(x,y) – generate a plot of the values of x and y using logarithmic scales for both x and y
 Multiple Curves:
 plot (x, y, w, z) – multiple curves can be plotted on the same graph by using multiple arguments
in a plot command. The variables x, y, w, and z are vectors. Two curves will be plotted: y vs. x,
and z vs. w.
 legend (‘string1’, ‘string2’,…) – used to distinguish between plots on the same graph
 exercise: type help legend to learn more on this command.

 Multiple Figures:
 figure (n) – used in creation of multiple plot windows. place this command before the plot()
command, and the corresponding figure will be labeled as “Figure n”
 close – closes the figure n window.
 close all – closes all the figure windows.
 Subplots:
 subplot (m, n, p) – m by n grid of windows, with p specifying the current plot as the
pth window
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MatLab Workshop 1-28 Peng Liu
Plotting (con’t…)
 Example: (polynomial function)
plot the polynomial using linear/linear scale, log/linear scale, linear/log scale, & log/log scale:
y = 2x2 + 7x + 9

% Generate the polynomial:

x = linspace (0, 10, 100);
y = 2*x.^2 + 7*x + 9;

% plotting the polynomial:

figure (1);
subplot (2,2,1), plot (x,y);
title ('Polynomial, linear/linear scale');
ylabel ('y'), grid;
subplot (2,2,2), semilogx (x,y);
title ('Polynomial, log/linear scale');
ylabel ('y'), grid;
subplot (2,2,3), semilogy (x,y);
title ('Polynomial, linear/log scale');
xlabel('x'), ylabel ('y'), grid;
subplot (2,2,4), loglog (x,y);
title ('Polynomial, log/log scale');
xlabel('x'), ylabel ('y'), grid;

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MatLab Workshop 1-29 Peng Liu
Plotting (con’t…)

Stefano Corradin
MatLab Workshop 1-30 Peng Liu
Plotting (con’t…)
 Adding new curves to the existing graph:
 Use the hold command to add lines/points to an existing plot.
 hold on – retain existing axes, add new curves to current axes. Axes are
rescaled when necessary.
 hold off – release the current figure window for new plots
 Grids and
Labels:
Command Description

grid on Adds dashed grids lines at the tick marks

grid off removes grid lines (default)

grid toggles grid status (off to on, or on to off)

title (‘text’) labels top of plot with text in quotes

xlabel (‘text’) labels horizontal (x) axis with text is quotes

ylabel (‘text’) labels vertical (y) axis with text is quotes

text (x,y,’text’) Adds text in quotes to location (x,y) on the current axes, where (x,y) is in units
from the current plot.

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MatLab Workshop 1-31 Peng Liu
Additional commands for plotting

color of the point or curve Marker of the data Plot line styles
points
Symbol Marker
Symbol Line Style
Symbol Color . •
– solid line
y yellow
o °
m magenta : dotted line
x ×
c cyan –. dash-dot line
r red + +
–– dashed line
g green * ∗
b blue s □
w white
d ◊
k black
v ∇

^ ∆

h hexagram

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MatLab Workshop 1-32 Peng Liu
Flow control - selection
 The if-elseif-else construction
if <logical expression>
<commands>
elseif <logical expression>
<commands>
else
<commands>
end

Stefano Corradin
MatLab Workshop 1-33 Peng Liu
Logical expressions (try help)
 Relational operators (compare arrays of same sizes)
 == (equal to) ~= (not equal)
< (less than) <= (less than or equal to)
> (greater than) >= (greater than or equal to)

 Logical operators (combinations of relational operators)

 & (and)
| (or)
~ (not)

 Logical functions
xor
isempty
any
all
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MatLab Workshop 1-34 Peng Liu
M-Files
So far, we have executed the commands in the command
window. But a more practical way is to create a M-file.
 The M-file is a text file that consists a group of
MATLAB commands.
 MATLAB can open and execute the commands
exactly as if they were entered at the MATLAB
command window.
 To run the M-files, just type the file name in the
command window. (make sure the current
working directory is set correctly)

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MatLab Workshop 1-35 Peng Liu
Scripts or function: when use what?
 Functions
 Take inputs, generate outputs, have internal
variables
 Solve general problem for arbitrary parameters

 Scripts
 Operate on global workspace
 Document work, design experiment or test

 Solve a very specific problem once

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MatLab Workshop 1-36 Peng Liu
User-Defined Function
 Add the following command in the beginning of your m-file:
function [output variables] = function_name (input variables);

NOTE: the function_name

should be the same as your
file name to avoid confusion.
 calling your function:
-- a user-defined function is called by the name of the m-
file, not the name given in the function definition.
-- type in the m-file name like other pre-defined
commands.
 Comments:
-- The first few lines should be comments, as they will be
displayed if help is requested for the function name. the
first comment line is reference by the lookfor command.
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MatLab Workshop 1-37 Peng Liu
Branching-IF ELSEIF (example)
 Typea=2, if a>1,b=1,else b=0,end
 Or make a m-file (script) named aa.m
type.m
a=11 % example of branching for type of options
if a>10 K=105
if S==K
b=2 disp('At the Money Option')
elseif a>1 elseif S > K
b=1 disp('In the Money Option')
else dx
else b=0 = f (Option')
disp('Out the Money x, t )
end end dt

 Give a stock price S=125; enter type in command

window
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MatLab Workshop 1-38 Peng Liu
Flow control - repetition
 Repeats a code segment a fixed number of times
for index=<vector>
<statements>
end
 The <statements> are executed repeatedly.
At each iteration, the variable index is assigned
a new value from <vector>.
 Example: CRR Binomial Model

Stefano Corradin
MatLab Workshop 1-39 Peng Liu
Flow control – conditional repetition
 while-loops
while <logical expression>
<statements>
End
 <statements> are executed repeatedly as long as
the <logical expression> evaluates to true

Stefano Corradin
MatLab Workshop 1-40 Peng Liu
Flow control – conditional repetition
 Solutions to nonlinear equations

 can be found using Newton’s method

 Task: write a function that finds a solution to

 Given , iterate maxit times or until

Stefano Corradin
MatLab Workshop 1-41 Peng Liu
Flow control – conditional repetition

newton.m
function [x,n] = newton(x0,tol,maxit)
% NEWTON – Newton’s method for solving equations
% [x,n] = NEWTON(x0,tol,maxit)
x = x0; n = 0; done=0;
while ~done,
n = n + 1;
x_new = x - (exp(-x)-sin(x))/(-exp(-x)-cos(x));
done=(n>=maxit) | ( abs(x_new-x)<tol );
x=x_new;
end

 >> [x,n]=newton(0,eps,10)
Stefano Corradin
MatLab Workshop 1-42 Peng Liu
Black Vol using Newton Method
 Result:
x=
0.5885
n=
6
 Question:code a function that produce Black-
Scholes Volatility from Option prices!!

Stefano Corradin
MatLab Workshop 1-43 Peng Liu
Function functions
 Do we need to re-write newton.m for every new
function?
 No! General purpose functions take other m-files
as input.
>> help feval
>> [f,f_prime]=feval(’myfun’,0);
myfun.m
function [f,f_prime] = myfun(x)
% MYFUN– Evaluate f(x) = exp(x)-sin(x)
% and its first derivative
% [f,f_prime] = myfun(x)

f=exp(-x)-sin(x);
f_prime=-exp(-x)-cos(x);
Stefano Corradin
MatLab Workshop 1-44 Peng Liu
Function functions
 Can update newton.m newtonf.m
function [x,n] = newtonf(fname,x0,tol,maxit)
% NEWTON – Newton’s method for solving equations
% [x,n] = NEWTON(fname,x0,tol,maxit)
x = x0; n = 0; done=0;
while ~done,
n = n + 1;
[f,f_prime]=feval(fname,x);
dx
x_new = x – f/f_prime;
= f ( x, t )
done=(n>maxit) | (dtabs(x_new-x)<tol );
x=x_new;
end

 >> [x,n]=newtonf(’myfun’,0,1e-3,10)
Stefano Corradin
MatLab Workshop 1-45 Peng Liu
Example: Pricing options in CRR
Binomial Tree
 Open P:\PodiumPC\2006MFE
 Double Click CRR.m
 It will open an editor window beginning with
function [] = CRR(CallPut, AssetP, Strike, RiskFree, Div, Time, Vol, nSteps)
% Computes the Cox, Ross & Rubinstein (1979) Binomial Tree for European
%Call/Put Option Values based on the following inputs:
% CallPut = Call = 1, Put = 0
% AssetP = Underlying Asset Price
% Strike = Strike Price of Option
% RiskFree = Risk Free rate of interest annualized eg. 0.05
% Div = Dividend Yield of Underlying
% Time = Time to Maturity in years
% Vol = Volatility of the Underlying
% nSteps = Number of Time Steps for Binomial Tree to take

Stefano Corradin
MatLab Workshop 1-46 Peng Liu
Example: Pricing options in CRR
Binomial Tree (cont.)
dt = Time / nSteps;

if CallPut
b = 1;
end
if ~CallPut
b = -1;
end

RR = exp(RiskFree * dt);
Up = exp(Vol * sqrt(dt));
Down = 1 / Up;
Q_up = (exp((RiskFree - Div) * dt) - Down) / (Up - Down);
Q_down = 1 - Q_up;
Df = exp(-RiskFree * dt); %Df: Discount Factor

Stefano Corradin
MatLab Workshop 1-47 Peng Liu
Example: Pricing options in CRR
Binomial Tree (cont.)
%Populate all possible stock prices and option values on the end notes of the tree

for i = 0:nSteps
state = i + 1;
St = AssetP * Up ^ i * Down ^ (nSteps - i);
Value(state) = max(0, b * (St - Strike));
End

%Since value on the end nodes are known by above,

% we start from nSteps-1 working backwards
% double for loop: outter-every steps; innter-every nodes on each step

for k = nSteps - 1 : -1 : 0
for i = 0:k
state = i + 1;
Value(state) = (Q_up * Value(state + 1) + Q_down * Value(state)) * Df;
end
end

Binomial = Value(1)
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MatLab Workshop 1-48 Peng Liu
Results

Stefano Corradin
MatLab Workshop 1-49 Peng Liu
Results

Set the current directory to where you

saved your “.m” file.

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MatLab Workshop 1-50 Peng Liu
Results

All your variables. You can edit them

here too.

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MatLab Workshop 1-51 Peng Liu
Results

Type the program name (without the

“.m”).

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MatLab Workshop 1-52 Peng Liu
Example: Pricing options in CRR
Binomial Tree (cont.)
 >> CRR(1,100,105,0.05,0,2,0.4,100)
Binomial =

24.3440
 >> CRR(0,100,105,0.05,0,2,0.4,100)
Binomial =

19.3520

Stefano Corradin
MatLab Workshop 1-53 Peng Liu
Results

Check your results!

Stefano Corradin
MatLab Workshop 1-54 Peng Liu
How to Leave Matlab?
 The answer to the most popular question
concerning any program is this: leave a
Matlab session
 Leave Matlab by typing
quit
 or by typing
exit
 To the Matlab prompt.

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MatLab Workshop 1-55 Peng Liu