Associate Professor Jackie Li 2016
AFIN270 Stochastic Methods in Applied Finance
Parameters vs Statistics

many variables of interest are random in nature, e.g. share
return, inflation rate, interest rate

parameters describe the true underlying mechani
Associate Professor Jackie Li 2016
AFIN270 Stochastic Methods in Applied Finance
Options

a contract

option holder has the right to buy (a call) / sell (a put) an
asset in future at a price agreed at issue date (strike price)

no obligation to buy / s
AFIN270
Sample MidSemester Test
September 2015
AFIN270 MidSemester Test  September 2015
Unit Code and Name: AFIN270 Stochastic Methods in Applied Finance
Time Allowed: One hour plus 5 minutes reading time
Total Number of Questions: 2
Instructions
W
Macquarie University
AFIN270 Stochastic Methods in Applied Finance
Exercise Mathematical Skills Required for this Course
Time Value of Money
1. Find the equivalent effective annual rate of interest for the following:
(a) j2 = 6%
2
0.06
1 = i
1+
2
i = 6.09
Macquarie University
AFIN270 Stochastic Methods in Applied Finance
Tutorial Exercises
Week 7 Mathematical Models of Asset Prices III
Conceptual Questions
1. Describe the key structure of a continuous time asset price model by
answering the following quest
AFIN270
Sample MidSemester Test
September 2015
AFIN270 MidSemester Test  September 2015
Unit Code and Name: AFIN270 Stochastic Methods in Applied Finance
Time Allowed: One hour plus 5 minutes reading time
Total Number of Questions: 2
Instructions
Writ
AFIN270
MidSemester Test
September 2015
AFIN270 MidSemester Test  September 2015
Unit Code and Name: AFIN270 Stochastic Methods in Applied Finance
Time Allowed: One hour plus 5 minutes reading time
Total Number of Questions: 2
Instructions
Write your
Macquarie University
AFIN270 Stochastic Methods in Applied Finance
Tutorial Exercises
Week 10 Numerical Methods in Stochastic Financial
Modelling II
Conceptual Questions
1. Explain the limitations of modelling randomness using a normal distribution with c
AFIN270
End of Year Examination Sample
November 2015
AFIN270 End of Year Examination (Sample Paper)  November 2015
Unit Code and Name: AFIN270 Stochastic Methods in Applied Finance
Time Allowed: Three hours plus 10 minutes reading time
Total Number of Qu
Macquarie University
AFIN270 Stochastic Methods in Applied Finance
Tutorial Exercises
Week 9 Numerical Methods in Stochastic Financial
Modelling I
Conceptual Questions
1. What additional information is provided by simulations in financial
modelling over u
AFIN270
End of Year Examination Sample
November 2015
AFIN270 End of Year Examination (Sample Paper)  November 2015
Unit Code and Name: AFIN270 Stochastic Methods in Applied Finance
Time Allowed: Three hours plus 10 minutes reading time
Total Number of Qu
Macquarie University
AFIN270 Stochastic Methods in Applied Finance
Tutorial Exercises
Week 8 RiskNeutral Pricing
Conceptual Questions
1. Describe the factors that influence the price of an asset in the market.
The size of the cash flows, the timing of th
Macquarie University
AFIN270 Stochastic Methods in Applied Finance
Tutorial Exercises
Week 6 Mathematical Models of Asset Prices II
N.B. You may notice that the continuously compounding rate of return
can be less than 100%. This may seem strange that inv
AFIN270
End of Year Examination Sample
November 2015
AFIN270 End of Year Examination (Sample Paper)  November 2015
Unit Code and Name: AFIN270 Stochastic Methods in Applied Finance
Time Allowed: Three hours plus 10 minutes reading time
Total Number of Qu
Macquarie University
AFIN270 Stochastic Methods in Applied Finance
Tutorial Exercises
Week 5 Mathematical Models of Asset Prices I
Given that the class test is in Week 6, this set of homework exercises will
not be collected in Week 6. However, you may be
AFIN270 Stochastic Methods in Applied Finance
Continuous Probability Distributions

a random variable is continuous (as opposed to discrete) if it

takes on an infinite number of possible values within a range
e.g. height and weight of a randomly select
AFIN270 Stochastic Methods in Applied Finance
Extreme Events

stock markets are experiencing extreme positive and negative

movements and volatility has increased in recent years
catastrophes, e.g. 2010/11 NZ Canterbury earthquakes, 2011

Thai floods r
AFIN270 Stochastic Methods in Applied Finance
Forwards

a contract
buyer / seller agrees to buy (long) / sell (short) an asset in

future (maturity date) at a preagreed price (forward price)
obligation to buy / sell
investment assets: shares, bonds, go
Associate Professor Jackie Li 2016
AFIN270 Stochastic Methods in Applied Finance
Continuous Probability Distributions

normal distribution

t distribution

exponential distribution

gamma distribution

lognormal distribution
1
Associate Professor Jac
Associate Professor Jackie Li 2016
AFIN270 Stochastic Methods in Applied Finance
Bayesian Analysis

conditional probability

Bayesian theory

Markov chain Monte Carlo simulation

Gibbs sampling
1
Associate Professor Jackie Li 2016
AFIN270 Stochastic M
Associate Professor Jackie Li 2016
AFIN270 Stochastic Methods in Applied Finance
Discrete Probability Distributions

Bernoulli distribution

binomial distribution

multinomial distribution

Poisson distribution

discrete uniform distribution
1
Associ
Associate Professor Jackie Li 2016
AFIN270 Stochastic Methods in Applied Finance
Modelling Extreme Events

generalised extreme value distribution

Gumbel distribution

Frchet distribution

reversed Weibull distribution

generalised Pareto distributio
ECON 111
Introduction + PPF (Production Possibilities Frontier)
1. Economic Models
2. Opportunity Costs
3. Marginal Analysis
1. Simplest example of a real situation, used to form useful simplifications of
economic problems.
2. When deciding to invest/buy
AFIN270 Stochastic Methods in Applied Finance
Business Ethics

ethical principles in a business environment
all aspects of business conduct
conduct of individuals and entire organisation
standards or values that govern the actions and behaviour
regulatin
AFIN270 Stochastic Methods in Applied Finance
Background to options

John owns a property worth $1m
John tells Sarah I am giving you the option to buy my

property in 6 months for $1.2m
Sarah says ok
In 6 months time Johns property price goes up to $1.5
Lecture 1 Measure of Location and Spread
AFIN270 Stochastic Methods in Applied Finance
What you will learn from this unit

appreciate the uncertain nature of the financial world
learn common methods to model and measure the uncertainty
more advanced tech
AFIN270 Stochastic Methods in Applied Finance
Regression Models

regression models are used to model linear relationships

between two or more variables
e.g. financial variables (interest rates and other economic

indicators, stock prices etc)
simple l
AFIN270 Stochastic Methods in Applied Finance
Joint Probability Distributions

multivariate normal distribution
multivariate t distribution
1
AFIN270 Stochastic Methods in Applied Finance
Joint Probability Distributions

joint probability density functi
AFIN270 Stochastic Methods in Applied Finance
Time Series Models

autoregressive (AR) model
moving average (MA) model
autoregressive moving average (ARMA) model
autoregressive integrated moving average (ARIMA) model
autoregressive conditional heterosceda