For the Black-Scholes-Merton differential equation we see the property that it does not involve any variables that are affected by the risk preferences of investors.The consequence of this is that the equation has solutions that adhere to risk-neutral principles.

a)What is the Principle of Risk Neutral Valuation and what is the procedure that leads to a risk-neutral valuation?

b)Apply the risk-neutral procedure to value a long forward contract on a non-dividend paying stock with price S , that matures at time T , and with delivery price K.

1. Show that this result satisfies the Black-Scholes-Merton differential equation.