more FIN 532 Practice Problems

Paskalis Glabadanidis and Yufeng Han

1. Portfolio insurance -- fee paid separately.

Set up a portfolio insurance strategy for a 2-period model with u=1.2, d=0.7 and r=1.05. Assume the floor is 100 (which is the same as the initial investment) and the fee is paid separately. Compute the cost of the put and the optimal initial proportion to be invested in the stock.

2. Portfolio insurance with a built-in fee.

Set up a portfolio insurance strategy for a 2-period model with u=1.2, d=0.7 and r=1.05. Let the initial investment be 100 and the floor be 80. Compute the proportion k of initial investment to allocate to the underlying portfolio, the cost of the put, and the initial optimal proportion to be invested in stocks. (Hint: The parameters are chosen so that the floor kicks in only in the worst state when the stock has gone down twice.)