PROBABILITY AND STATISTICS FOR ENGINEERS
9th Edition
ISBN: 9780136860969
Author: WALPOLE
Publisher: PEARSON
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Chapter 2.3, Problem 45E
To determine
Find the number of distinct permutations can be made from the letters of the word INFINITY.
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In this problem, we consider a Brownian motion (W+) t≥0. We consider a stock model (St)t>0
given (under the measure P) by
d.St 0.03 St dt + 0.2 St dwt,
with So 2. We assume that the interest rate is r = 0.06. The purpose of this problem is to
price an option on this stock (which we name cubic put). This option is European-type, with
maturity 3 months (i.e. T = 0.25 years), and payoff given by
F = (8-5)+
(a) Write the Stochastic Differential Equation satisfied by (St) under the risk-neutral measure
Q. (You don't need to prove it, simply give the answer.)
(b) Give the price of a regular European put on (St) with maturity 3 months and strike K = 2.
(c) Let X =
S. Find the Stochastic Differential Equation satisfied by the process (Xt)
under the measure Q.
(d) Find an explicit expression for X₁ = S3 under measure Q.
(e) Using the results above, find the price of the cubic put option mentioned above.
(f) Is the price in (e) the same as in question (b)? (Explain why.)
Problem 4. Margrabe formula and the Greeks (20 pts)
In the homework, we determined the Margrabe formula for the price of an option allowing you to
swap an x-stock for a y-stock at time T. For stocks with initial values xo, yo, common volatility
σ and correlation p, the formula was given by
Fo=yo (d+)-x0Þ(d_),
where
In (±²
Ꭲ
d+
õ√T
and
σ = σ√√√2(1 - p).
дго
(a) We want to determine a "Greek" for ỡ on the option: find a formula for
θα
(b) Is
дго
θα
positive or negative?
(c) We consider a situation in which the correlation p between the two stocks increases: what
can you say about the price Fo?
(d) Assume that yo< xo and p = 1. What is the price of the option?
We consider a 4-dimensional stock price model given (under P) by
dẴ₁ = µ· Xt dt + йt · ΣdŴt
where (W) is an n-dimensional Brownian motion,
π = (0.02, 0.01, -0.02, 0.05),
0.2
0
0
0
0.3
0.4
0
0
Σ=
-0.1
-4a За
0
0.2
0.4 -0.1 0.2)
and a E R. We assume that ☑0 = (1, 1, 1, 1) and that the interest rate on the market is r = 0.02.
(a) Give a condition on a that would make stock #3 be the one with largest volatility.
(b) Find the diversification coefficient for this portfolio as a function of a.
(c) Determine the maximum diversification coefficient d that you could reach by varying the
value of a?
2
Chapter 2 Solutions
PROBABILITY AND STATISTICS FOR ENGINEERS
Ch. 2.2 - List the elements of each of the following sample...Ch. 2.2 - Use the rule method to describe the sample space S...Ch. 2.2 - Which of the following events are equal?
A = {1,...Ch. 2.2 - An experiment involves tossing a pair of dice, one...Ch. 2.2 - Prob. 5ECh. 2.2 - Two jurors are selected from 4 alternates to serve...Ch. 2.2 - Prob. 7ECh. 2.2 - For the sample space of Exercise 2.4,
list the...Ch. 2.2 - Prob. 9ECh. 2.2 - Prob. 10E
Ch. 2.2 - Prob. 11ECh. 2.2 - Exercise and diet are being studied as possible...Ch. 2.2 - Prob. 13ECh. 2.2 - Prob. 14ECh. 2.2 - Consider the sample space S = {copper, sodium,...Ch. 2.2 - If S = {x | 0 < x < 12}, M = {x | 1 < x < 9}, and...Ch. 2.2 - Prob. 17ECh. 2.2 - Which of the following pairs of events are...Ch. 2.2 - Prob. 19ECh. 2.2 - Referring to Exercise 2.19 and the Venn diagram of...Ch. 2.3 - Registrants at a large convention are offered 6...Ch. 2.3 - In a medical study, patients are classified in 8...Ch. 2.3 - Prob. 23ECh. 2.3 - Students at a private liberal arts college are...Ch. 2.3 - A certain brand of shoes comes in 5 different...Ch. 2.3 - Prob. 26ECh. 2.3 - Prob. 27ECh. 2.3 - A drug for the relief of asthma can be purchased...Ch. 2.3 - Prob. 29ECh. 2.3 - In how many different ways can a true-false...Ch. 2.3 - A witness to a hit-and-run accident told the...Ch. 2.3 - In how many ways can 6 people be lined upto get on...Ch. 2.3 - If a multiple-choice test consists of 5 questions,...Ch. 2.3 - Prob. 34ECh. 2.3 - Prob. 35ECh. 2.3 - Prob. 36ECh. 2.3 - Prob. 37ECh. 2.3 - Prob. 38ECh. 2.3 - In a regional spelling bee, the 8 finalists...Ch. 2.3 - In how many ways can 5 starting positions on a...Ch. 2.3 - Find the number of ways that 6 teachers can be...Ch. 2.3 - Prob. 42ECh. 2.3 - Prob. 43ECh. 2.3 - In how many ways can a caravan of 8 covered wagons...Ch. 2.3 - Prob. 45ECh. 2.3 - In how many ways can 3 oaks, 4 pines, and 2 maples...Ch. 2.3 - How many ways are there to select 3 candidates...Ch. 2.3 - How many ways are there that no two students will...Ch. 2.5 - Find the errors in each of the following...Ch. 2.5 - Prob. 50ECh. 2.5 - A box contains 500 envelopes, of which 75...Ch. 2.5 - Suppose that in a senior college class of 500...Ch. 2.5 - The probability that an American industry will...Ch. 2.5 - From past experience, a stockbroker believes that...Ch. 2.5 - If each coded item in a catalog begins with 3...Ch. 2.5 - An automobile manufacturer is concerned about a...Ch. 2.5 - Prob. 57ECh. 2.5 - A pair of fair dice is tossed. Find the...Ch. 2.5 - In a poker hand consisting of 5 cards, find the...Ch. 2.5 - If 3 books are picked at random from a shelf...Ch. 2.5 - In a high school graduating class of 100 students,...Ch. 2.5 - Prob. 62ECh. 2.5 - Prob. 63ECh. 2.5 - Interest centers around the life of an electronic...Ch. 2.5 - Prob. 65ECh. 2.5 - Factory workers are constantly encouraged to...Ch. 2.5 - Consider the situation of Example 2.32 on page...Ch. 2.5 - Interest centers around the nature of an oven...Ch. 2.5 - Prob. 69ECh. 2.5 - Prob. 70ECh. 2.5 - As the situation of Exercise 2.69 might suggest,...Ch. 2.5 - Prove that
P(A′ ∩ B′) = 1+P(A ∩ B) − P(A) − P(B).
Ch. 2.6 - If R is the event that a convict committed armed...Ch. 2.6 - Prob. 74ECh. 2.6 - A random sample of 200 adults are classified below...Ch. 2.6 - In an experiment to study the relationship of...Ch. 2.6 - In the senior year of a high school graduating...Ch. 2.6 - A manufacturer of a flu vaccine is concerned about...Ch. 2.6 - In USA Today (Sept. 5, 1996), the results of a...Ch. 2.6 - Prob. 80ECh. 2.6 - Prob. 81ECh. 2.6 - For married couples living in a certain suburb,...Ch. 2.6 - The probability that a vehicle entering the Luray...Ch. 2.6 - The probability that the head of a household is...Ch. 2.6 - The probability that a doctor correctly diagnoses...Ch. 2.6 - In 1970, 11% of Americans completed four years of...Ch. 2.6 - A real estate agent has 8 master keys to open...Ch. 2.6 - Before the distribution of certain statistical...Ch. 2.6 - A town has two fire engines operating...Ch. 2.6 - Prob. 90ECh. 2.6 - Find the probability of randomly selecting 4 good...Ch. 2.6 - Prob. 92ECh. 2.6 - A circuit system is given in Figure 2.11. Assume...Ch. 2.6 - Prob. 94ECh. 2.7 - In a certain region of the country it is known...Ch. 2.7 - Police plan to enforce speed limits by using...Ch. 2.7 - Referring to Exercise 2.95, what is the...Ch. 2.7 - If the person in Exercise 2.96 received a speeding...Ch. 2.7 - Suppose that the four inspectors at a film factory...Ch. 2.7 - A regional telephone company operates three...Ch. 2.7 - A paint-store chain produces and sells latex and...Ch. 2.7 - Prob. 102ECh. 2.7 - Prob. 103RECh. 2.7 - An allergist claims that 50% of the patients she...Ch. 2.7 - Prob. 105RECh. 2.7 - Prob. 106RECh. 2.7 - Prob. 107RECh. 2.7 - Prob. 108RECh. 2.7 - A large industrial firm uses three local motels to...Ch. 2.7 - The probability that a patient recovers from a...Ch. 2.7 - Prob. 111RECh. 2.7 - Prob. 112RECh. 2.7 - Prob. 113RECh. 2.7 - Prob. 114RECh. 2.7 - A certain federal agency employs three consulting...Ch. 2.7 - A manufacturer is studying the effects of cooking...Ch. 2.7 - Prob. 117RECh. 2.7 - A certain form of cancer is known to be found in...Ch. 2.7 - A producer of a certain type of electronic...Ch. 2.7 - Prob. 120RECh. 2.7 - Prob. 121RECh. 2.7 - Prob. 122RECh. 2.7 - Prob. 123RECh. 2.7 - Prob. 124RECh. 2.7 - A survey of those using a particular statistical...Ch. 2.7 - During bad economic times, industrial workers are...Ch. 2.7 - There is a 50-50 chance that the queen carries the...
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- Question 1. Your manager asks you to explain why the Black-Scholes model may be inappro- priate for pricing options in practice. Give one reason that would substantiate this claim? Question 2. We consider stock #1 and stock #2 in the model of Problem 2. Your manager asks you to pick only one of them to invest in based on the model provided. Which one do you choose and why ? Question 3. Let (St) to be an asset modeled by the Black-Scholes SDE. Let Ft be the price at time t of a European put with maturity T and strike price K. Then, the discounted option price process (ert Ft) t20 is a martingale. True or False? (Explain your answer.) Question 4. You are considering pricing an American put option using a Black-Scholes model for the underlying stock. An explicit formula for the price doesn't exist. In just a few words (no more than 2 sentences), explain how you would proceed to price it. Question 5. We model a short rate with a Ho-Lee model drt = ln(1+t) dt +2dWt. Then the interest rate…arrow_forwardIn this problem, we consider a Brownian motion (W+) t≥0. We consider a stock model (St)t>0 given (under the measure P) by d.St 0.03 St dt + 0.2 St dwt, with So 2. We assume that the interest rate is r = 0.06. The purpose of this problem is to price an option on this stock (which we name cubic put). This option is European-type, with maturity 3 months (i.e. T = 0.25 years), and payoff given by F = (8-5)+ (a) Write the Stochastic Differential Equation satisfied by (St) under the risk-neutral measure Q. (You don't need to prove it, simply give the answer.) (b) Give the price of a regular European put on (St) with maturity 3 months and strike K = 2. (c) Let X = S. Find the Stochastic Differential Equation satisfied by the process (Xt) under the measure Q. (d) Find an explicit expression for X₁ = S3 under measure Q. (e) Using the results above, find the price of the cubic put option mentioned above. (f) Is the price in (e) the same as in question (b)? (Explain why.)arrow_forwardThe managing director of a consulting group has the accompanying monthly data on total overhead costs and professional labor hours to bill to clients. Complete parts a through c. Question content area bottom Part 1 a. Develop a simple linear regression model between billable hours and overhead costs. Overhead Costsequals=212495.2212495.2plus+left parenthesis 42.4857 right parenthesis42.485742.4857times×Billable Hours (Round the constant to one decimal place as needed. Round the coefficient to four decimal places as needed. Do not include the $ symbol in your answers.) Part 2 b. Interpret the coefficients of your regression model. Specifically, what does the fixed component of the model mean to the consulting firm? Interpret the fixed term, b 0b0, if appropriate. Choose the correct answer below. A. The value of b 0b0 is the predicted billable hours for an overhead cost of 0 dollars. B. It is not appropriate to interpret b 0b0, because its value…arrow_forward
- Using the accompanying Home Market Value data and associated regression line, Market ValueMarket Valueequals=$28,416+$37.066×Square Feet, compute the errors associated with each observation using the formula e Subscript ieiequals=Upper Y Subscript iYiminus−ModifyingAbove Upper Y with caret Subscript iYi and construct a frequency distribution and histogram. LOADING... Click the icon to view the Home Market Value data. Question content area bottom Part 1 Construct a frequency distribution of the errors, e Subscript iei. (Type whole numbers.) Error Frequency minus−15 comma 00015,000less than< e Subscript iei less than or equals≤minus−10 comma 00010,000 0 minus−10 comma 00010,000less than< e Subscript iei less than or equals≤minus−50005000 5 minus−50005000less than< e Subscript iei less than or equals≤0 21 0less than< e Subscript iei less than or equals≤50005000 9…arrow_forwardThe managing director of a consulting group has the accompanying monthly data on total overhead costs and professional labor hours to bill to clients. Complete parts a through c Overhead Costs Billable Hours345000 3000385000 4000410000 5000462000 6000530000 7000545000 8000arrow_forwardUsing the accompanying Home Market Value data and associated regression line, Market ValueMarket Valueequals=$28,416plus+$37.066×Square Feet, compute the errors associated with each observation using the formula e Subscript ieiequals=Upper Y Subscript iYiminus−ModifyingAbove Upper Y with caret Subscript iYi and construct a frequency distribution and histogram. Square Feet Market Value1813 911001916 1043001842 934001814 909001836 1020002030 1085001731 877001852 960001793 893001665 884001852 1009001619 967001690 876002370 1139002373 1131001666 875002122 1161001619 946001729 863001667 871001522 833001484 798001589 814001600 871001484 825001483 787001522 877001703 942001485 820001468 881001519 882001518 885001483 765001522 844001668 909001587 810001782 912001483 812001519 1007001522 872001684 966001581 86200arrow_forward
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