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Comm 374 Assignment #4
Question1
a) Using the course formula gives F=S(1+R)= 40*1.04 = $41.60
b) Hedging a long forward position is going to be less costly due to dividend. Using the
duplication argument (see the table in Slide 13) it can be shown that F=(S –PV(D))
(1+R)= (40 2/1.04^0.75)*1.04= $39.58. Another method will lead to the same
conclusion is to assume that XYZ delivered a dividend of FV(D)=2*1.04^0.25 at the end
of year in which case the formula of slide 13 is directly applicable: F=40*.104 
2*1.04^0.25=$39.58.
c) F = 45*(1.04)^0.5=$45.89.
Question2:
a.
It is easy to check that R2=4%, R3=4.5% and R1=4.26%
b.
We construct a cash and carry strategy whereby we short the forward, we buy
Bond 3 and borrow its price (98.68), we get the no arbitrage price
F=98.67*1.0426 – 4 =98.67
Question3.
a.
First you calculate the stock tree:
48.4
44
40
39.6
36
32.4
The option payoff at the end (last three nodes) are
0
2.4
9.6
Then using the method in the course, you can easily derive the delta/B to calculate by
backward induction the price in each node. The result is
B
12.80988
delta
0.27273
0
0.80988
1
Delta
0.4936
2.1184
8
2.4
1
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This note was uploaded on 04/17/2011 for the course COMM 299 taught by Professor Desrochers during the Spring '08 term at The University of British Columbia.
 Spring '08
 DESROCHERS

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