Question

2.1 A stock price has an expected return of 15% and a volatility of 25%. It is currently $56.
2.1.1 What is the probability that it will be greater than $85 in two years? (4)
2
2.1.2 What is the stock price that has a 5% probability of being exceeded in two years? (2)
2.2 A binary option pays off $150 if a stock price is greater than $40 in three months. The
current stock price is $35 and its volatility is 35%. The risk-free rate is 4% and the expected
return on the stock is 10%.
2.2.1 What is the value of the option? (6)
2.2.2 What is the real-world probability that the payoff will be received? (4)
2.3 An investor owns 12,000 shares of a particular stock. The current market price is R100.
What is the “worst case” value of the portfolio in six months? For the purposes of this
question, define the worst case value of the portfolio as the value which is such that there
is only a 1% chance of the actual value being lower. Assume that the expected return and
volatility of the stock price are 8.5% and 23%, respectively. (4)
2.4 You are a risk manager at World Finance Ltd, the CEO has asked you to provide a brief
report to him on the definition of traffic light options and what their drawbacks will be for
the organisation. Correctly reference two academic articles that deals with traffic light
options for the CEO report.

Answer 1