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 Investment / Financial Markets Old Exam MFE Forum

#1
04-11-2017, 01:54 AM
 DansGinger Member CAS SOA Join Date: Jan 2017 Posts: 170
New MFE manual (Am I tackling the exam wrong)

I feel like my study approach just isnt working and I'm not sure how to go about studying for this exam.

It seems like every page I go to, I am super confused about what the author is doing (I am using the new ASM manual btw). For example, page 117, the formula (delta = (C_u - C_d)/(S(u-d))*e^(-delta * h)) makes no sense to me. Furthermore, on page 120, the whole calculating variance of ln(u) and ln(d) and using Bernoulli variables makes no sense. Am I missing something crucial?

Chapter 7 was also really confusing and although I read the whole chapter, I probably only understood about 60% of it.

Any tips of how to tackle this exam? Much appreciated..
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#2
04-11-2017, 10:13 AM
 The Disreputable Dog Member CAS Join Date: Dec 2011 Studying for prelims College: Somersby School Favorite beer: Worldwide Stout Posts: 855

Do you have the textbook to supplement your reading? I thought McDonald did a nice enough job explaining many of the concepts.

RE: the formula for delta, I find the concept of delta easiest to remember graphically. It's the slope of a line which connects two points on an option payoff chart. Particularly in the binomial model for stocks, we're only ever looking at two possible values of St at a time (Su and Sd). Each of those corresponds to two different payoff amounts for the option (Cu and Cd for a call). Skipping over the issue of why a line between them works, you can draw a line between those two points. The slope of that line is the rise/run, or (change in payoff)/(change in stock).

The above omits the e^(-δh), and I remember it that way intentionally. I've found it much much easier to keep track of things if you use subscripts on delta and beta. So I remember Δf = (Cu-Cd)/(Su-Sd) for the future number of shares - which is what you're looking for when you're evaluating payoffs, since they happen at expiration. To get Δp you just pull it back to the present value of those shares. Which you do using e^(-δh) for shares of a stock.

Bf = (u*Cd - d*Cu)/(u-d) for the future amount of a risk-free investment or loan. Bp = e^(-rh)*Bf for the present value.

Neither McDonald nor ASM seem to go with the subscripts, but I find them really useful. It also simplifies the formulas for delta and beta just a little bit since you can jettison the mechanism that moves them back and forth in time.
#3
04-11-2017, 03:04 PM
 dqbrooks14 Member Non-Actuary Join Date: Sep 2016 Posts: 43

Delta didn't make sense to me until I learned what it actually was in terms of being an option Greek. It's definition is dV/dS which is exactly what the formula you gave is in a discrete time sense discounted back to present value.