1.

4 Exercises
1. Find the Taylor series expansions of the following functions about x = 0
(by rst using a Binomial expansion in part a) and then considering how
the function in part b) is related to that in part a)).
a)
f (x) =
1
1 x
:
b)
f(x) = ln(1 + x):
2. Find the limiting behaviour of

1 +
x
n

nt
as n !1.
3. The BlackScholes Equation (BSE) is a linear parabolic PDE, given by
@V
@t
+
1
2

2
S
2
@
2
V
@S
2
+ (r D) S
@V
@S
rV = 0;
where ; r and D are constants. The unknown function V = V (S; t) :
Find all separable solutions of the form V (S; t) = (S) (t).
Hint: When substituting in (S) (t) ; the BSE will be transformed
into a pair of ODEs for which you should seek general solutions.
Consider each of the three cases.
4. Using a trinomial random walk and Taylor series, derive the backward
Kolmogorov partial dierential equation.
@p
@t
+ c
2
@
2
p
@y
2
= 0
for the transition density function p(y; t ; y
0
; t
0
).
By simple substitution show that
1
2c
p
(t
0
t)
exp

(y
0
y)
2
4c
2
(t
0
t)

satises the backward Kolmogorov equation.

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