Question 11 (8 points)

A one-month binomial model comprises of an underlying asset (shares), selling at $65. The price of underlying asset can go either up 30% or down 22%. The risk-free rate is 8% per annum compounded continuously.

Required:

1. Determine the price of a one-month European put option with an exercise price of $70.
2. Calculate the number of underlying asset (shares) that should be bought or sold to hedge 10,000 put options.

Formulae:

Option Price: f= e^-rt [pf_u + (1-p)f_d]

Question 13 (5 points)

You manage a large portfolio consisting of multiple asset classes and securities/assets in multiple geographic locations. You would like to know the sources of total exposure of the portfolio.

Required:

Discuss how can risk-factor analysis be useful for this purpose.

Question 15 (4 points)

Alex works as a credit analyst at Happylife Bank. A corporate client of the bank has applied for a long-term loan of $2 million.

Required:

Briefly describe two methods Alex can use to decide if the loan should be approved.