Sample Application F in the DerivaGem Application Builder Software considers the static options replication example in Section 22.13. It shows the way a hedge can be constructed using four options (as in Section 22.13) and two ways a hedge can be constructed using 16 options.

(a) Explain the difference between the two ways a hedge can be constructed using 16 options. Explain intuitively why the second method works better.

(b) Improve on the four-option hedge by changing Tmat for the third and fourth options.

(c) Check how well the 16-option portfolios match the delta, gamma, and vega of the barrier option.

AppendixLO1