Task:
a) Describe the process of determining VaR/ES using the Historical Simulation.Identify and discuss two advantages and two disadvantages of this modelling approach.
b) Identify and explain four key differences between forwards and futures.
c) Explain what is meant by the term independent and identically distributed (i.i.d.).
d) Consider a 6mth forward contract on a non-dividend paying stock with current price €28, delivery price of €32. Demonstrate that this presents an arbitrage opportunity. (The risk-free rate is 2%).
e) Describe what is meant by the volatility term structure and explain the term moneyness.
Consider a European call on a stock with a current price of €16 that will move up to €18 or down to €14 at the end of 1mth. The call has a strike of €15 and expires in 1mth. You can assume the risk-free rate of interest is 1.15% per annum. Recalling that p (the probability of an upward movement) can be calculated:
r is the risk-free rate of interest
T is the time to expiration
u is the upward multiplier
d is the downward multiplier
a) The binomial tree is a popular approach to option pricing.
i. Complete the entries in the tree to determine the price of the call option attime 0.
iii. Using the same principles, verify and explain put-call parity.
b) Discuss the key issues with the modelling assumptions used in securitised structures, which contributed to the events of the 2007-2009 financial crisis.
Question 3
a) An orange juice producer is concerned about future market prices for their product.
i. Describe the use of futures to manage this risk
ii. Describe the use of options to manage this risk.
iii. Discuss the benefits and disadvantages of both approaches.
c) Explain and discuss the issue of funding liquidity risk.
