Financial engineering deals with the design of new assets. Draw the payoff (at t=1) of the...

 

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Financial engineering deals with the design of new assets. Draw the payoff (at t=1) of the following bull butterfly spread: Purchase I call with exercise price a Sell 2 calls with exercise price (a+b)/2 Purchase I call with exercise price b as a function of the underlying stock price 5 at t=1 where a-120and b-140. [2p] (b) An individual agent thinks that there is a high probability that the Dow Jones will have a payoff (or points) between a-32,000 and b-36,000 at 1-1. Design a digital option (see Figure 1) as a sequence of calls on the Dow that converges to a pure bet on getting $1 on the interval [32,000, 36,000], i.e. if the Dow lies between S=[32,000, 36,000] at t-1, then the portfolio of calls pays off exactly $1. The payoff is 0 otherwise. [4pl Figure 1 (Digital option) payoff 1 a=32,000 b-36,000 Hint: You have to modify the sell strategies of a bull butterfly spread to obtain a payoff as given in Figure 2 and then adjust n and appropriately. Figure 2 payoff of portfolio 1-no a ato b-6 b Financial engineering deals with the design of new assets. Draw the payoff (at t=1) of the following bull butterfly spread: Purchase I call with exercise price a Sell 2 calls with exercise price (a+b)/2 Purchase I call with exercise price b as a function of the underlying stock price 5 at t=1 where a-120and b-140. [2p] (b) An individual agent thinks that there is a high probability that the Dow Jones will have a payoff (or points) between a-32,000 and b-36,000 at 1-1. Design a digital option (see Figure 1) as a sequence of calls on the Dow that converges to a pure bet on getting $1 on the interval [32,000, 36,000], i.e. if the Dow lies between S=[32,000, 36,000] at t-1, then the portfolio of calls pays off exactly $1. The payoff is 0 otherwise. [4pl Figure 1 (Digital option) payoff 1 a=32,000 b-36,000 Hint: You have to modify the sell strategies of a bull butterfly spread to obtain a payoff as given in Figure 2 and then adjust n and appropriately. Figure 2 payoff of portfolio 1-no a ato b-6 b

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Ball Butterfly Spread Payoff Part a Scenario Purchase 1 call option with exercise price strike price a 120 Sell 2 call options with exercise price str... View the full answer