In the world of mathematical finance, an important skill for any quantitative analystis to price derivatives. These usually come in the form of options as well as other moreexotic financial instruments. For this project we will focus on something called EuropeanCall options. We will see how you can estimate the price of an underlying asset (usually astock) at some time in future T and use this to find how much an option should cost today.First, lets take a look at what a European call option actually is.The idea behind the European call option is that you will enter into a contract withsomeone that grants you the right, but not the obligation, to purchase some number ofshares of a stock at a pre-determined price, called the strike price. In this paper we will saythat the payoff for a European call option can be given by: max {S(t) – K, 0}. The reason wedo this is because, it would not make sense to exercise the option if the price of theunderlying asset is below the strike price, K. Suppose that you could purchase shares onthe open market at $10 per share, but your strike price was set at $12, you would not paymore money for the stock, if you didn't have to do that.In the space below, sketch the payoff function that is described by max{S(T) – K, 0}.Explain why your sketch makes sense:

Answer : The payoff function for a European call option is given by max{S(T) - K, 0}, where S(T)…

Answered: In the world of mathematical finance,…

Advanced Engineering Mathematics

10th Edition

ISBN:9780470458365

Author:Erwin Kreyszig

Publisher:Erwin Kreyszig

Chapter2: Second-order Linear Odes

Section: Chapter Questions

Problem 1RQ

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