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Practice problems

Practice problems - 1 Certainty equivalent method In class...

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1. Certainty equivalent method – In class we discussed the pricing of Boomers, Busters and Bogglers, but didn’t calculate the actual prices. Do so using the certainty equivalent method. Assume that each year the market return is either 20% or 4%, with equal probability. A Boomer is a perpetuity that pays \$200 each year r m = 20% and 0 otherwise. A Buster is a perpetuity that pays \$200 each year r m = 4% and 0 otherwise. A Boggler is a perpetuity that pays \$200 each year r m = 4% and pays -\$200 otherwise. That is, the Boggler has the same payoffs as a portfolio that is long one Buster and short one Boomer. Assume r f = 5%. 2. In class we discussed put-call parity . I’d like you to check whether option prices conform to put-call parity. Pick a stock (other than Google) with traded options. (In general, technology stocks and stocks with more volatile returns tend to have more active options markets.) Use Yahoo!Finance, or some other data source, to get the prices of a put and call with the same strike price and maturity date as each other. You want to pick options that are somewhat actively traded, therefore choose “at-the-money” options (with strike prices close to the current stock price). Determine the risk-free rate that corresponds with the maturity of the options.

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Practice problems - 1 Certainty equivalent method In class...

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