1. Explain exactly what is meant by 'synthetic replication'.Write clear explanation ofhow synthetic replication is relevant to the valuation of derivatives.In this part of the question you must give a clear definition of replication and some general discussion about how synthetic replication affects the prices of derivatives in the market. (2 marks)
2. Usingeither(i) forward/futures contracts or (ii) option contracts giveone explicit numerical exampleof synthetic replication and how the price of the derivative security is related to the synthetically replicated portfolio. You only need to use one example.You must address the principles of synthetic replication for the derivative security you have chosen for your illustration. (2 marks)