Gullit SC 424 (0101) FINAL EXAM , DEC. 16 2008 THERE ARE FIVE PROBLEMS, EACH 20 POINTS ‘The Black Sholes formula is given by, Cas(s,t, K,o,1) = sw) — Kew — ov) , where (r+02/2)t—log(s/K) ovt ‘ and @ is the standard normal distribution 1+ Assume that X and ¥ are two discrete random variables that have probability densities P(X = 2) for £=1,2,...mand P(Y = yy) for j =1,2...n, respectively. a) (5pts.) Express B[XY] as an appropriate sum, using the joint probability density, P(X = 24 and Y = yy) ) (6 pts.) Express Cov(X,¥) as an appropriate sum. c) (10 pts.) Assume that X and ¥ are independent and compute Cou(X,¥’). What is the correlation of X and ¥? 2+ Suppose that you take a loan of 10,0008 at a yently interest rate of 6% to be compounded monthly. a) (15 pts.) Compute the monthly payment if you want to pay off the loan after three years. ') (5 pts.) What is the total amount that you pay after three years? B+ Let Z be a standard normal random variable with mean 0 and standard deviation 1 and a some fixed number. a) (10 pts.) Express the conditional probability distribution, P(-00<%S2|Z Sa) as a function of ®. ») (5 pts) Show that the conditional probability density is given by 1 Vie See) nie 2 and you do not exercise if $(t1) < 2. Show that this number is the solution of the equation P(e (0/2)VE) 2/2) At — log(x/ K1) G5 where i= oe and Ats= th 4) (6 pts.) Suppose that at time t you can either exercise the option or you can sell the stock short and put it back at time ta by either buying it or exercising the call option. Which strategy is better? u