Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

QUESTION 6(2+3+1+3+1+2=12 marks ) Consider an institution with three option positions against the same underlying stock. The maturities of all the options exceed one year.

image text in transcribed

QUESTION 6(2+3+1+3+1+2=12 marks ) Consider an institution with three option positions against the same underlying stock. The maturities of all the options exceed one year. The institution seeks to hedge their option exposure over the next three weeks by taking a position in the stock. You are provided with the following information a) What does the evolution of the deltas imply about the trajectory of the underlying stock price over the next two weeks? Why? [2 marks] b) Calculate the dynamic position in the stock (to 2decimalplaces)thatisrequiredtodeltahedge the overall exposure now (week 0), and at the end of weeks 1 and 2. [3 marks] c) Given that units of stock cannot be purchased or sold to 2 decimal places, what are the likely hedging implications of rounding the stock position to the nearest integer? [1 mark] d) Show how the hedging strategy in b) changes now and at the end of weeks 1 and 2, if each option position is hedged independently of the other positions, i.e. consider independently hedging option 1 , independently hedge option 2 etc. [3 marks] QUESTION 6(2+3+1+3+1+2=12 marks ) Consider an institution with three option positions against the same underlying stock. The maturities of all the options exceed one year. The institution seeks to hedge their option exposure over the next three weeks by taking a position in the stock. You are provided with the following information a) What does the evolution of the deltas imply about the trajectory of the underlying stock price over the next two weeks? Why? [2 marks] b) Calculate the dynamic position in the stock (to 2decimalplaces)thatisrequiredtodeltahedge the overall exposure now (week 0), and at the end of weeks 1 and 2. [3 marks] c) Given that units of stock cannot be purchased or sold to 2 decimal places, what are the likely hedging implications of rounding the stock position to the nearest integer? [1 mark] d) Show how the hedging strategy in b) changes now and at the end of weeks 1 and 2, if each option position is hedged independently of the other positions, i.e. consider independently hedging option 1 , independently hedge option 2 etc. [3 marks]

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

The Economics Of Money Banking And Financial Markets

Authors: Frederic S. Mishkin

11th Global Edition

1292094184, 978-1292094182

More Books

Students also viewed these Finance questions

Question

Differentiate 3sin(9x+2x)

Answered: 1 week ago

Question

Compute the derivative f(x)=(x-a)(x-b)

Answered: 1 week ago