Chapter16 - Chapter Sixteen Financial Engineering and Risk...

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Chapter Sixteen Financial Engineering and Risk Management Answers to Problems and Questions 1. Finance is based on the premise that the easy access to information will result in few free lunches. People prefer more wealth to less, everything else being equal, and will always seek to improve their own welfare. Studies of pricing relationships, fair value, and optimum strategies are all based on the assumption that the best strategy is the one that achieves a desired goal with the least risk. 2. Financial engineering refers to the construction of asset portfolios that have precise technical characteristics, particularly when those characteristics are not conveniently available in an existing exchange product. 3. Writing calls provides downside protection that is limited to the option premium received. Puts provide much more complete protection, as they become more valuable as prices continue to fall. 4. Subsequent increases in the stock market, which should cause the value of the stock portfolio to increase, will be largely offset by losses from the marking to market of the futures contracts. 5. We measure theta in dollars. Dollars are fungible across all option premiums. Economically, one option that will lose 10 cents per day has the same effect on portfolio value as two options that will each lose a nickel per day. Option deltas, however, are particular to the underlying asset. While you can add dollars, it is not as meaningful to add a GM delta to a GE delta. 6. Writing options may reduce the cost of engineering some option portfolio,
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This note was uploaded on 01/31/2011 for the course ACCT 331 taught by Professor N/a during the Spring '10 term at Mountain State.

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Chapter16 - Chapter Sixteen Financial Engineering and Risk...

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