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Quantitative Finance and Investment (QFI) track Exam CSP - Company/Sponsor Perspective

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Old 02-26-2016, 05:18 PM
komorgan komorgan is offline
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Default Mistake in Paul Wilmott Introduces Quant. Finance Solution Manual?

Hello,


http://www.wiley.com/legacy/wileychi...2/supp/c08.pdf

Had a question about the answer to Question 5 in the attached link. Specifically, in the scenario where the stock increases until expiration (i.e. Situation A), I'm confused about the part where it says "The cost
of buying the share in this fashion should be equal to the initial
premium for the option plus the exercise price, E"

I did an experiment (see attached workbook) where the stock increases over 10 years, and the call option writer rehedges his/her position at the end of each year by purchasing more (or less) stock, according to the change in the value of delta (N[d1]).

Ultimately, the total net cost of purchasing stocks (100.28) was about equal to ONLY the exercise price (100), NOT equal to exercise price PLUS premium (which I assume was the initial value of the option, 58.24).

Is that quoted statement incorrect, or did I make a mistake in my math?

Thanks.
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Old 02-28-2016, 02:17 PM
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Bell Bell is offline
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There is no 'apparent' problem in the proposed solution.

the discounted net cost of hedging shall be equal to the call option value (under the BS model).

Under scenario (a): The net cost of hedging = (The cost of purchasing the shares to remain delta neutral during the period)-(The exercise price).

Under scenario (b): The net cost of hedging=The total loss incurred when shorting shares to remain delta neutral.
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Old 02-28-2016, 02:19 PM
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.....In addition.....


Any 'calculated' difference between the discounted net cost of hedging and the B/S price may be due to (i) frequency of re-balancing and more practically, to (ii) transaction costs.
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