NBA 673  Introduction to Derivatives I (Solutions)
Final Exam  March 11, 2006
Name and Cornell ID:
1 Instructions
This exam contains 13 pages printed on one side only, and 5 problems. Please check now
that you have a complete exam. If not, ask for another copy.
This exam is "closed books, closed notes." However, you can have a single page of
formulas, but with no regular text on it. You can use a calculator.
Your answers should be as clear, complete, and concise as possible. Try to eliminate
any ambiguity in your answers. Write legibly  we will ignore answers that can not be
reasonably deciphered. If you change your mind about an answer, make sure you cross
out the parts that you do not want us to consider. Do not provide more than one answer
to any question. If you do, we will randomly choose one version of the answer to grade,
and we will ignore all the others.
A numerical answer by itself will not be worth much unless you show in detail how you
computed it. You must provide the underlying formula(s) for any computation that you
perform, and show how the various numerical quantities are "plugged" into the formula
you show your work, we will be able to follow your reasoning and provide you with partial
credit by penalizing you for the initial mistake only, and not also for its consequences.
If you need to make assumptions beyond those provided in the problems, feel free to
do so, but state that you rely on such assumptions, provide them explicitly, and clearly
explain why you needed them.
You are not allowed to cooperate with anybody else on this exam. All work submitted
must be exclusively yours. Do not provide any kind of assistance to anybody else.
2 Financial Assumptions
When approaching the problems below, feel free to assume the following:
1. Interest rates are positive.
2. There are no transactions costs, nor taxes.
In addition, one can trade, lend or
borrow unlimited amounts of any instrument, including cash.
Neither interest
rates, nor prices will change as a result of trading, lending, or borrowing by any one
individual. Fractional trading, lending or borrowing is possible.
3. There are no arbitrage opportunities.
Good Luck!
1
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True/False Questions [18 Points]
Answer all the questions below by simply stating whether they are TRUE of FALSE.
You do not need to provide any proofs or arguments beyond the answer.
(a) It is never optimal to exercise an American put early.
False. The maximum payo/ of an American option with strike price
K
occurs
when the stock price falls to
0
.
Once this happens, one should certainly
exercise the option as early as possible (the proceeds can then be reinvested in
other instruments). Other  less extreme  situations can also justify the early
exercise of American puts.
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 Spring '06
 JANOSI,TIBOR
 Interest Rates, Forward contract, coupon payment

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