Quantitative Finance and Investments Core Formula Sheet

Spring 2014

Morning and afternoon exam booklets will include a formula package identical to the one attached to this
study note. The exam committee believe that by providing many key formulas, candidates will be able to
focus more of their exam preparation time on the application of the formulas and concepts to demonstrate
their understanding of the syllabus material and less time on the memorization of the formulas.
The formula sheet was developed sequentially by reviewing the syllabus material for each major syllabus
topic. Candidates should be able to follow the flow of the formula package easily. We recommend that
candidates use the formula package concurrently with the syllabus material. Not every formula in the
syllabus is in the formula package. Candidates are responsible for all formulas on the syllabus,
including those not on the formula sheet.
Candidates should carefully observe the sometimes subtle dierences in formulas and their application to
slightly dierent situations. For example, there are several versions of the Black-Scholes-Merton option
pricing formula to dierentiate between instruments paying dividends, tied to an index, etc. Candidates will
be expected to recognize the correct formula to apply in a specific situation of an exam question.
Candidates will note that the formula package does not generally provide names or definitions of the formula
or symbols used in the formula. With the wide variety of references and authors of the syllabus, candidates
should recognize that the letter conventions and use of symbols may vary from one part of the syllabus to
another and thus from one formula to another.
We trust that you will find the inclusion of the formula package to be a valuable study aide that will allow
for more of your preparation time to be spent on mastering the learning objectives and learning outcomes.
In sources where some equations are numbered and others are not (nn) denotes that there is no number
assigned to that particular equation.

An Introduction to the Mathematics of Financial Derivatives, 2nd Edition, S.

Neftci

Chapter 2
(10)
(66)
(67)
(70)
(71)
(nn)

1
(1 + r)
(1 + r)
S(t) = S1 (t + 1) S2 (t + 1) 1
2
C(t)
C1 (t + 1) C2 (t + 1)

i
1 h
St =
Pup (St + ) + Pdown (St )
1+r
i
h
1
up
down
+ Pdown Ct+
Ct =
Pup Ct+
(1 + r)
i
(1 + d) h u u
S=
S P + S d P d
(1 + r)
i
h
1
C=
C u P u + C d P d
(1 + r)

Ct+
EP
= 1 + r
Ct

Chapter 3
(37)

(49)

Z T
n
X
ti + ti1
f
f (s)ds
(ti ti1 )
2
0
i=1

Z T
n
X
ti + ti1

g(s)df (s) =
g
(f (ti ) f (ti1 ))
2
0
i=1

Chapter 4
(24)

1
1
dF (t) = Fs dSt + Fr drt + Ft dt + Fss dSt2 + Frr drt2 + Fsr dSt drt
2
2

Chapter 5
(11)
(18)
(19)
(40)
(41)
(44)
(45)

E[St |Iu ] =

St f (St |Iu )dSt ,

u<t

P (F (t) = +a ) = p

P (F (t) = a ) = (1 p)

P (Xt+s xt+s |xt , . . . , x1 ) = P (Xt+s xt+s |xt )

rt+ rt = E[(rt+ rt )|It ] + (It , t)Wt

drt = (rt , t)dt + (rt , t)dWt

1
rt+
1 rt + 1 Rt
1 Wt+
=
+
2
Rt+
2 rt + 2 Rt
2 Wt+

Chapter 6
(3)
(4)
(5)

Et [ST ] = E[ST |It ],

t<T

E |St | <

Et [ST ] = St , for all t < T

2

(10)

EtP [eru Bt+u ] = Bt ,

(11)

EtP [eru St+u ] = St ,

NtG

0<u

NtB

(22)

Mt =

(27)

P (NtG = 1)
= G > P (NtB = 1)
= B

(28)

Et [Mt ]
= G B > 0

(41)
(44)

0<u<T t

Xt N (, 2 )
Z t+T
dXu
Xt+T = X0 +
0

(48)
(52)

Zt = Xt t

Et [Zt+T ] = Xt t

(53)

Et [Zt+T ] = Zt

(54)

St N (0, 2 )

(55)

S0 = 0

(56)

Zt = St2

(58)

Et [Zt+T 2 (T + t)] = Zt 2 t

(62)
(63)
(64)

It It+1 . . . IT 1 IT
Mt = E P [YT |It ]

E P [Mt+s |It ] = Mt

(69)

GT = f (ST )

(70)

BT = e

(71)
(105)

Mt = E

T
t

rs ds

GT
|It
BT

Mtk = Mt0 +

k
X
i=1

(107)
(111)

Hti1 [Zti Zti1 ]

Et0 [Mtk ] = Mt0

Z T
Z
CT = Ct +
Ds ds +
t

g(Cs )dMs
t

Chapter 7
(24)

Wk = [Sk Sk1 ] Ek1 [Sk Sk1 ]

(27)

Wk =

k
X

Wi

i=1

(29)

Ek1 Wk = Wk1

(30)

Vk = E0 [Wk2 ]
" n
#2
n
X
X
V = E0
Wk =
Vk

(31)

k=1

k=1

(32)

V > A1 > 0

(34)

V < A2 <

(35)

Vmax = max[Vk , k = 1, . . . , n]
k

(36)

Vk
> A3 , 0 < A3 < 1
Vmax

(37)

E[Wk ]2 = k2 h

(52)

Sk Sk1 = Ek1 [Sk Sk1 ] + k Wk

Chapter 8

1 with probability dt
0 with probability 1 dt

(7)

dNt =

(8)

Mt = Nt t

(9)

(14)

(15)
(17)

E[Mt ] = 0

w1

w2
k Wk =
..

wm
2

E[k Wk ] =
m
X

with probability p1
with probability p2
..
.
with probability pm

k2 h

pi wi2 = k2 h

i=1

(22)

wi (h) = w
i hri

(23)

pi (h) = pi hqi

(27)

qi + 2ri = 1

(28)

ci = w
i2 pi

(53)

Jt = (Nt t)

(55)

dSt = a(St , t)dt + 1 (St , t)dWt + 2 (St , t)dJt

(70)

t0 = 0 < t1 < . . . < tn = T

(71)

n = T

(72)
(73)

Si = Sti , i = 0, 1, . . . , n

ui Si with probability pi
Si+1 =
di Si with probability 1 pi

(74)

ui = e

(75)
(76)
(85)

, for all i

di = e

, for all i
i
pi =
, for all i
1+
2

Si+n
Si
1h

(86)
(87)

Si+n
= Z log u + (n Z) log d
Si
u
Si+n
= Z log + n log d
log
Si
d

log

Chapter 9

(37)
(38)
(39)

lim E

" n
X

k=1

(Sk1 , k) [Wk Wk1 ]

(Su , u)dWu
0

#2

=0

Sk Sk1 = a(Sk1 , k)h + (Sk1 , k)[Wk Wk1 ], k = 1, 2, . . . , n

#
"Z
T
(St , t)2 dt <
E
0

(41)

n
X

k=1

(73)

(74)

(76)
(77)
(78)
(79)
(85)

(Sk1 , k)[Wk Wk1 ]

xt dxt =

If

(St , t)dWt

1 2
xT T
2
0
"n1
#2
X
2
lim E
xti+1 T = 0

i=0

T
2

(dxt ) exists, then lim E

n

"n1
X

x2ti+1

i=0

(dxt )

dt = T
0
T
2

(dxt ) =
0

dt

(dWt )2 = dt
Z t
Z
Es
u dWu =
0

u dWu , 0 < s < t

0

Chapter 10
(nn)

dSt = at dt + t dWt ,

(36)

dFt =

(37)
(64)

t0

F
F
1 2F 2
dSt +
dt
dt +
St
t
2 St2 t

F
F
F
1 2F 2
dFt =
at +

t dWt
+
t dt +
2
St
t
2 St
St

Z t
Z t
1
2
Fs dSu = [F (St , t) F (S0 , 0)]
Fu + Fss u du
2
0
0

#2

=0

(69)

dFt = Ft dt + Fs1 dS1 + Fs2 dS2 +

(79)

Y (t) =

(80)

n
X

Ni (t)Pi (t)

i=1
n
X

dY (t) =

Ni (t)dPi (t) +

i=1

(81)
(82)
(83)

(84)

(85)

(86)

n
X

1
Fs1 s1 dS12 + Fs2 s2 dS22 + 2Fs1 s2 dS1 dS2
2

dNi (t)Pi (t) +

i=1

"

Jt = Nt t h
at = t + t

k
X

"

k
X

ai pi

i=1

ai pi

i=1

!#

#
k
X
1
2
dF (St , t) = Ft + t
(F (St + ai , t) F (St , t))pi + Fss dt + Fs dSt + dJF
2
i=1
" k
#
X

dJF = [F (St , t) F (St , t)] t

(F (St + ai , t) F (St , t))pi dt
i=1

(87)

St

= lim Ss , s < t
st

Chapter 11
(24)

dSt = St dt + St dWt , t [0, )

(30)

St = S0 e{(a 2

(34)

dSt = rSt dt + St dWt , t [0, )

h
i

1 2
ST = S0 e(r 2 )T eWT

(38)

)t+Wt }

(42)

Zt = eWt

(50)

xt = E[Zt ] = e 2

(56)

St = er(T t) Et [ST ]
p
dSt = St dt + St dWt , t [0, )

(72)
(74)
(78)
(79)
(80)

dNi (t)dPi (t)

i=1

dSt = at dt + t dWt + dJt , t 0

E[Jt ] = 0

n
X

dSt = ( St )dt + St dWt

dSt = St dt + dWt
dSt = dt + t dW1t

dt = (0 t )dt + t dW2t

Chapter 12
Note - Formulas (24), (26), and (28) are incorrect in the text. The correct versions are given here.

(3)

Pt = 1 F (St , t) + 2 St

(4)

dPt = 1 dFt + 2 dSt

(5)

dSt = a(St , t)dt + (St , t)dWt , t [0, )

(6)
(7)

1
dFt = Ft dt + Fss t2 dt + Fs dSt
2

1
2
dFt = Fs at + Fss t + Ft dt + Fs t dWt
2

(10)

1 = 1

(11)

2 = Fs

(12)
(16)
(17)
(23)
(24)
(26)
(28)
(nn)
(29)

1
dPt = Ft dt + Fss t2 dt
2
1
r(F (St , t) Fs St ) = Ft + Fss t2
2
1
rF + rFs St + Ft + Fss t2 = 0, 0 St , 0 t T
2
Pt = F (St , t) Fs (St , t)St

dPt = dF (St , t) Fs dSt St dFs dFs (St , t)dSt

1
2 2
dPt = dF (St , t) Fs dSt St Fst + Fss St + Fsss t St dt + Fss St dWt Fss t2 St2 dt
2

dPt = dF (St , t) Fs dSt St [Fss ( r)St dt] Fss St2 dWt

dWt = (dWt + ( r)dt)

a0 F + a1 Fs St + a2 Ft + a3 Fss = 0, 0 St , 0 t T

(30)

F (ST , T ) = G(ST , T )

(32)

Ft + Fs = 0, 0 St , 0 t T

(33)

F (St , t) = St t +

(44)

F (St , t) = eSt t

(46)

.3Fss + Ftt = 0

(47)

F (St , t) =

(53)

1
.3
(St S0 )2 + (t t0 )2 + (St S0 )(t t0 )
2
2
F (St , t) = 10(St 4)2 3(t 2)2 , 10 t 10, 10 St 10

Chapter 13
(1)

a(St , t) = St

(2)

(St , t) = St ,

(3)
(4)
(6)

t [0, )

1
rF + rFs St + Ft + Fss 2 St2 = 0, 0 St , 0 t T
2
F (T ) = max[ST K, 0]

F (St , t) = St N (d1 ) Ker(T t) N (d2 )

(7)
(8)
(9)
(17)
(18)
(19)
(20)
(21)
(30)
(31)
(32)
(33)
(34)

ln(St /K) + (r + 12 2 )(T t)

T t

d2 = d1 T t
Z d1
1
1 2
e 2 x dx
N (d1 ) =
2

1
rF rFs St + Fs St Ft Fss t2 = 0
2
F (S1T , S2T , T ) = max[0, max(S1T , S2T ) K] (multi-asset option)
d1 =

F (S1T , S2T , T ) = max[0, (S1T S2T ) K] (spread call option)

F (S1T , S2T , T ) = max[0, (1 S1T + 2 S2T ) K] (portfolio call option)

F (S1T , S2T , T ) = max[0, (S1T K1 ), (S2T K2 )] (dual strike option)

F
F
1
2 F
+ rS
+ 2 S 2
= rF
t
S
2
S 2
F Fij Fi,j1
=
t
t
F
Fij Fi1,j
rS
= rSj
S
S
Fi+1,j Fij
F
rS
= rSj
S
S

2
F Fi+1,j Fij
Fij Fi1,j
1

=
S 2
S
S
S

Chapter 14
(6)
(7)

1
1
dP (
z ) = P z dzt < zt < z + dzt
2
2
Z
dP (zt ) = 1

(8)

E[zt ] =

zt dP (zt )

(9)
(29)
(31)
(41)

E [zt E[zt ]] =

1
Et
St+1 = St
(1 + Rt )

EtP
St+1 = St
(1 + rt )
zt N (0, 1)

(42)

2
1
1
dP (zt ) = e 2 (zt ) dzt
2

(43)

(zt ) = ezt 2

(44)
(45)

[zt E[zt ]] dP (zt )

2
1
1 2
1
[dP (zt )][(zt )] = e 2 (zt )+zt 2 dzt
2
2
1
1
dP (zt ) = e 2 [zt ] dzt
2

(46)

dP (zt ) = dP (zt )(zt )

(48)

(zt )1 dP (zt ) = dP (zt )

(53)

f (z1t , z2t ) =

12

1
p

12
22

(54)

(55)

2
|| = 12 22 12

(56)
(57)
(58)

(59)

(60)

12

||

12

dP (z1t , z2t ) = f (z1t , z2t )dz1t dz2t

(

12
(z1t , z2t ) = exp z1t z2t
12

dP (z1t , z2t ) = (z1t , z2t )dP (z1t , z2t )

12 z1t z2t

1
p
dP (z1t , z2t ) =
e
2 ||
0

(zt ) = ezt

(74)
(75)

dP (zt ) = (zt )1 dP (zt )

(76)
(77)
(83)

t = Wt
W

Xu du, t [0, T ]

(86)

t = dWt Xt dt
dW
dPT = T dP

A1 + A2 + + An =

(123)

1A1 + 1A2 + . . . 1An = 1 = 1

(127)

E P [Zt 1Ai ] = P (Ai )

Z
P
E [g(Xt )] =
g(x)f (x)dx

(138)

(nn)
(nn)

g(Xt ) = Zt h(Xt )
Z

E P [g(Xt )] =
h(x)f(x)dx = E P [h(x)]

12
12

PT (A) = E P [1A T ]

(122)

(85)

(93)

t
t
2
1
t = e( 0 Xu dWu 2 0 Xu du) , t [0, T ]
h t 2 i
E e 0 Xu du < , t [0, T ]
Z u
Z t
s Xs dWs |Iu =
s Xs dWs
E

(84)

12
22

+ 12 0 1

dP (zt )
= (zt )
dP (zt )
dP (zt ) = (zt )dP (zt )

(69)

(z1t 1 ) (z2t 2 )

12
22

12
12

1
2

12
22

1
1
+
2

z1t
z2t

(z1t 1 )
(z2t 2 )

dz1t dz2t

12
12

12
22

1
2

Chapter 15
(2)
(4)

Yt N (t, 2 t)

M () = E[eYt ]
1

t2

(10)

M () = et+ 2

(15)

St = S0 eYt , t [0, )

(25)

E[St |Su , u < t] = Su e(ts)+ 2

(30)
(31)
(32)
(38)
(42)
(51)
(58)

(ts)

Zt = ert St

E P ert St |Su , u < t = eru Su

E P [Zt |Zu , u < t] = Zu

i
h
1 2

E P er(tu) St |Su , u < t = Su er(tu) e(tu)+ 2 (tu) where P N (t, 2 t)

E P ert St |Su , u < t = eru Su

t
dSt = rSt dt + St dW
i
h

Ct = EtP er(T t) max{ST K, 0}

(88)

dSt = t dt + t dWt

(90)

d[ert St ] = ert [t rSt ]dt + ert t dWt

(92)
(97)
(98)
(111)

t = dXt + dWt
dW

t rSt
dXt =
dt
t
t
d[ert St ] = ert t dW
rt

t
d e F (St , t) = ert t Fs dW

Chapter 17
(6)

(13)

1
0
Bts1
Bt1
Ct1

Rt1 Rtu2
(Ft1 Lut2 )
1
Btuu
3
Ctuu
3

Rt1 Rtu2
(Ft1 Lut2 )
1
Btud
3
Ctud
3

Rt1 Rtd2
(Ft1 Ldt2 )
1
Btdd
3
Ctdd
3

1 = Rt1 Rtu2 uu + Rt1 Rtu2 ud + Rt1 Rtd2 du + Rt1 Rtd2 dd

(14)

P ij = (1 + rt1 )(1 + rti2 ) ij

(15)

1 = P uu + P ud + P du + P dd

(16)

P ij > 0

(18)

Bts1 = E P

(21)

Bt1 = E P

(22)

Rt1 Rtd2
(Ft1 Ldt2 )
1
Btdu
3
Ctdu
3

0=E

1
(1 + rt1 )(1 + rt2 )
Bt3
(1 + rt1 )(1 + rt2 )

1
[Ft Lt2 ]
(1 + rt1 )(1 + rt2 ) 1
10

uu
ud

du

dd

(23)
(31)

1
Ct1 = E
Ct
(1 + rt1 )(1 + rt2 ) 3

1
1

h
i EP
Lt2
Ft1 =
1
(1 + rt1 )(1 + rt2 )
E P
P

(1+rt1 )(1+rt2 )

(36)

Bts1

(38)

ij =

(39)

1 = uu + ud + du + dd

(46)

Ft1 = E [Lt2 ]

(52)

Ct3 = N max[Lt2 K, 0]

1
P
Ct1 = E
max[Lt2 K, 0]
(1 + rt1 )(1 + rt2 )

(53)
(55)
(56)
(61)
(62)
(63)

uu

+ ud + du + dd

1 ij

Bts1

Ct1 = Bts1 E max[Lt2 K, 0]

i
h
T +

Vt = EtP e t ru du (Ft LT )N

Vt = Et [B(t, T + )(Ft LT )N ]
Vt = B(t, T + )Et [(Ft LT )N ]
Ft = Et [LT ]

Chapter 18
(3)
(12)
(20)
(33)
(39)
(40)

B(t, T ) = eR(t,T )(T t) , t < T

h
i
T

B(t, T ) = EtP e t rs ds
h
i
T

log EtP e t rs ds
R(t, T ) =
T t
B(t, T ) = e

T
t

F (t,s)ds

log B(t, T ) log B(t, T + )

log B(t, T ) log B(t, U )

F (t, T, U ) =
U T

F (t, T ) = lim

Chapter 19
(14)

dBt = (t, T, Bt )Bt dt + (t, T, Bt )Bt dVtT

(15)

dBt = rt Bt dt + (t, T, Bt )Bt dWtT

(t, T, B(t, T ))
(t, T, B(t, T ))
dF (t, T ) = (t, T, B(t, T ))
dt +
dWt
T
T

(21)
(22)

dF (t, T ) = a(F (t, T ), t)dt + b(F (t, T ), t)dWt

(25)

rt = F (t, t)

11

(nn)

F (t, T ) = F (0, T ) +

b(s, T )

(26)

rt = F (0, t) +

b(s, t)

(33)

"Z

b(s, u)du ds +

b(s, T )dWs
0

Z t
b(s, u)du ds +
b(s, t)dWs
0

dF (t, T ) = b (T t)dt + bdWt

(34)

dB(t, T ) = rt B(t, T )dt + b(T t)B(t, T )dWt

(36)

1
rt = F (0, t) + b2 t2 + bWt
2
drt = (Ft (0, t) + b2 t)dt + bdWt

(37)

Ft (0, t) =

(35)

F (0, t)
t

Paul Wilmott Introduces Quantitative Finance, 2nd Edition, P. Wilmott

Chapter 6
(6.6)
(6.7)
(6.8)
(6.9)
(6.10)

2V
V
V
1
+ 2 S 2 2 + rS
rV = 0
t
2
S
S
V
V
1
2V
+ 2 S 2 2 + (r D)S
rV = 0
t
2
S
S
V
V
1
2V
+ 2 S 2 2 + (r rf )S
rV = 0
t
2
S
S
V
V
1
2V
+ 2 S 2 2 + (r + q)S
rV = 0
t
2
S
S
2V
V
1
+ rV = 0
+ 2 F 2
t
2
F 2

Chapter 8
er(T t)
V (S, t) = p
2(T t)

(8.7)

d1

d2

=
=

e(log(S/S

)+(r 12 2 )(T t))2 /2 2 (T t)

Call option value

SeD(T t) N (d1 ) Eer(T t) N (d2 )
log(S/E)+(rD+ 12 2 )(T t)

T t
log(S/E)+(rD 12 2 )(T t)

T t

d1 T t

Put option value

SeD(T t) N (d1 ) + Eer(T t) N (d2 )
Binary call option value
er(T t) N (d2 )
Binary put option value
er(T t) (1 N (d2 ))

12

Payo(S 0 )

dS 0
S0

Delta of common contracts

Call
eD(T t) N (d1 )
Put
eD(T t) (N (d1 ) 1)
Binary call

Binary put

er(T t) N 0 (d2 )

S T t
r(T t) 0
e S TNt(d2 )
1 2
N 0 (x) = 12 e 2 x

Gamma of common contracts

Call
Put
Binary call
Binary Put

eD(T t) N 0 (d1 )

S T t
D(T t) 0
e
N (d1 )

S T t
r(T t)
d1 N 0 (d2 )
e 2 S2 (T
t)
er(T t) d1 N 0 (d2 )
2 S 2 (T t)

Thetas of common contracts

Call
Put
Binary call
Binary put

D(T t) 0
Se 2T tN (d1 ) + DSN (d1 )eD(T t) rEer(T t) N (d2 )
D(T t) 0
N (d1 )
Se 2T t
DSN (d1 )eD(T t) + rEer(T t) N (d2 )

rer(T t) N (d2 ) + er(T t) N 0 (d2 ) 2(Td1t) rD

T t

rer(T t) (1 N (d2 )) er(T t) N 0 (d2 )

d1
2(T t)

rD

T t

Speed of common contracts

D(T t) 0
Call
e 2 S 2 (TNt)(d1 ) d1 + T t

D(T t) 0
Put
e 2 S 2 (TNt)(d1 ) d1 + T t

r(T t) 0
(d2 )
1 d2
Binary call
e 2 S 3 (TNt)
2d1 + 1d
T t

er(T t) N 0 (d2 )
1d
1 d2

Binary put
+
2d
2
3
1
S (T t)
T t
Vegas of common
contracts

Call
S T teD(T t) N 0 (d1 )
Put
S T teD(T t) N 0 (d1 )
Binary call
er(T t) N 0 (d2 ) d1
Binary put
er(T t) N 0 (d2 ) d1

Call
Put
Binary call
Binary put

Rhos of common contracts

E(T t)er(T t) N (d2 )
E(T t)er(T t) N (d2 )
(T t)er(T t) N (d2 ) + Tt er(T t) N 0 (d2 )
(T t)er(T t) (1 N (d2 )) Tt er(T t) N 0 (d2 )

Sensitivity to dividend for common contracts

Call
(T t)SeD(T t) N (d1 )
Put
(T t)SeD(T t) N (d1 )
T t r(T t) 0
Binary call

e
N (d2 )

T t r(T t) 0
Binary put
N (d2 )
e
13

Chapter 9
All formulas are in Section 9.3
2 =
Ri =

N
1 X 2
R
N i=1 i

Si Si1
Si1
n

n2 =
2 + (1 )

1X 2
R
n i=1 i

2
n2 = n1
+ (1 )Rn2

2
n2 =
2 + (1 )(n1
+ (1 )Rn2 )

2
2
E[n+k
] = E[n+k1
]

2
E[n+k
]=
2 + E[n2 ]
2 (1 )k

=
1 (1 )(1 )

2
n
1X
Ci
2
log
CC =
n i=1
Ci1
2
n
X
Hi
1
Parkinson: p2 =
log
4n log(2) i=1
Li

!
n
1X
Ci
Hi
Hi Li
Hi
Li
2
Garman & Klass: gk =
0.019 log
0.511 log
log
2 log
log
2
n i=1
Li
Oi
Oi
Oi
Oi

n
1X
Hi
Hi
Li
Li
2
Rogers & Satchell: rs
=
log
log
+ log
log
n i=1
Ci
Oi
Ci
Oi

Chapter 10
Section 10.4, one time step mark-to-market profit (using Black-Scholes with =
)

1 2
2 )S 2 i dt + (i a )(( r + D)Sdt + SdX)
(
2

Section 10.5, mark-to-market profit from today to tomorrow

1 2
2 S 2 i dt

2

Chapter 14
(14.1)

V = P ey(T t) +

N
X

Ci ey(ti t)

i=1

Chapter 16
(16.4)
(16.5)

V
V
1 2V
+ w2 2 + (u w)
rV = 0
t
2
r
r
V
dV rV dt = w
(dX + dt)
r
14

16.6 NAMED MODELS

16.6.1 Vasicek
dr = ( r)dt + 1/2 dX
The value of a zero coupon bond is given by eA(t;T )rB(t;T )
B=

1
(1 e(T t) )

A=

1
1
B(t; T )2
(B(t;
T
)

T
+
t)(

2
2
4

16.6.2 Cox, Ingersoll & Ross

dr = ( r)dt + rdX
The value of a zero coupon bond is given by eA(t;T )rB(t;T )

A = a2 log(a B) + 2 b log((B + b)/b) a2 log a

2
2(e1 (T t) 1)
B(t; T ) =
( + 1 )(e1 (T t) 1) + 21
p

1 = 2 + 2 and 2 =
a+b
p
+ 2 + 2
b, a =

16.6.3 Ho & Lee

dr = (t)dt + 1/2 dX
The value of a zero coupon bond is given by eA(t;T )rB(t;T )
B =T t
Z T
1
(s)(T s)ds + (T t)3
A=
6
t
(t) =

2
log ZM (t ; t) + (t t )
t2

Section 16.7
Forward price =

S
Z

Z
Z
1 2Z
+ w2 2 + (u w)
rZ = 0
t
2
r
r
with Z(r, T ) = 1
Section 16.8
Futures price F (S, r, t) =

S
p(r, t)

p
p 1 2 2 p
+ ( w)
+ w
rp w2
2
t
2 r
r

p
r

+ p

with p(r, T ) = 1
15

p
=0
r

Chapter 17
Section 17.2 Ho & Lee
dr = (t)dt + cdX
Z(r, t : T ) = eA(t;T )r(T t)

ZM (t ; T )
1

A(t; T ) = log
(T t) log(ZM (t ; t)) c2 (t t )(T t)2

ZM (t ; t)
t
2
Section 17.3 The Extended Vasicek Model of Hull & White
dr = ( r)dt + cdX

dr = ((t) r)dt + cdX

Z(r, t : T ) = eA(t;T )rB(t;T )

1
B(t; T ) =
1 e(T t)

2
ZM (t ; T )
c2 (T t )

(tt )
2(tt )
A(t; T ) = log
(t
;
t))

1
e
e

B(t;
T
)
log(Z
M
ZM (t ; t)
t
4 3

Chapter 18
Section 18.3.1 Bond Options - Market Practice
Call option price: er(T t) (F N (d01 ) EN (d02 ))

Put option price: er(T t) (EN (d02 ) F N (d01 ))

log(F/E) + 12 2 (T t)

T t

d02 = d01 T t
d01 =

Section 18.4.3 Caps and Floors - Market Practice

Caplet price: er

(ti t)

Floorlet price: er

(F (t, ti1 , ti )N (d01 ) rc N (d02 ))

(ti t)

(F (t, ti1 , ti )N (d01 ) + rc N (d02 ))

log(F/rc ) + 12 2 ti1

ti1
p
d02 = d01 ti1

d01 =

Section 18.6.1 Swaptions, Captions and Floortions - Market Practice

2(Ts T ) !
1 r(T t)
1
Price of a payer swaption: e
1 1+ F
(F N (d01 ) EN (d02 ))
F
2

2(Ts T ) !
1
1 r(T t)
1 1+ F
(EN (d02 ) F N (d01 ))
Price of a receiver swaption: e
F
2
log(F/E) + 12 2 (T t)

T t

d02 = d01 T t

d01 =

16

Chapter 19
T
t

(19.1)

Z(t; T ) = e

(19.2)

dZ(t; T ) = (t, T )Z(t; T )dt + (t, T )Z(t; T )dX

(nn)

F (t; T ) =

F (t;s)ds

log Z(t; T )
T

1 2
(t, T ) (t, T ) dt
(t, T )dX
2
T
!
Z
T
(t, s)ds dt + (t, T )dX
dF (t; T ) = (t, T )

dF (t; T ) =
T

(19.3)
(19.5)

(19.6)

dF (t; T ) =

N
X

i (t, T )

i=1

(19.7)

dZi = rZi dt + Zi

i1
X

i (t, s)ds dt +
t

N
X

i (t, T )dXi

i=1

aij dXj

j=1

i
X
dZi = (1 + Fi )dZi+1 + Zi+1 dFi + i Fi Zi+1
ai+1,j ij dt

(19.8)

j=1

i
X

j j
ij
i Fi dt + i Fi dXi
dFi =
1
+

F
j
j=1

(19.9)

FAQs in Option Pricing Theory, P. Carr

rT

(38)

T = [V (S0 , 0; i ) V (S0 , 0; h )]e

(39)

NT = f 0 (ST )

(40)

+ ST f (ST ) f (ST ) +

P &LT NT ST T f (ST ) = [V (S0 , 0; i ) V (S0 , 0; h )]e

rT

er(T t) (t2 h2 )

T
0

er(T t) (h2 t2 )

The Handbook of Fixed Income Securities, 8th ed., F. Fabozzi

Page 202

Yd =

(F P ) 360

F
t

Managing Investment Portfolios, a dynamic process, Maginn, et al

Chapter 5
(5-1)

2
Um = E(Rm ) 0.005RA m

(5-2)

SFRatio =

(5-3)
(5-4)

E(RP ) RL
P

E(Rnew ) RF
E(Rp ) RF
>
Corr(Rnew , Rp )
new
p

ALM
Um
= E(SRm ) 0.005RA 2 (SRm )

17

St2 2
V (St , t; h )dt
2 S 2
St2 2
V (St , t; h )dt
2 S 2

Quantitative Financial Economics: Stocks, Bonds and Foreign Exchange, K.

Cuthbertson and K. Nitzsche (QFIC 101-13)
Chapter 24
(1)

P = SP or p = s + p

(2)

p = s + p

(3)

S r = P S/P

(4a)

s = p p

(4b)

s = p p

b1
[f + b1 (w p ) + a2 (y y)] + (p + s)
1 b1

(5)

p =

(6)

f + b1 (w p ) + a2 (y y) = 0

(7)

A(1 + r) = (A/S)(1 + r )F

(8)

F/S = (1 + r)/(1 + r )

(9)

f s = r r

(10)
(11)

e
St+1
/St = (1 + rt )/(1 + rt )

set+1 st = rt rt

(12)

e
1 + Et Rt+1 (UK US) St+1
(1 + rt )/St

(13)

Et Rt+1 rt = i (Et Rm,t+1 rt )

(14)

ft = Et st+1

(15)

set+1 = set+1 st = (r r )t

(16)
(17)

set+1 = pet+1 pe
t+1

rt pet+1 = rt pe
t+1

Modern Investment Management: An Equilibrium Approach, B. Litterman

(QFIC 106-13)
Chapter 10
(10.1)

RL,t Rf,t = (RB,t Rf,t ) + t

(10.2)

SRi =

(10.3)

St At Lt

(10.4)
(10.6)
(10.8)

(10.9)

i Rf
i

Ft At /Lt
RACSt =

Et [At (1 + RA,t+1 ) Lt (1 + RL,t+1 ) (At Lt ) (1 + Rf )]

t [At (1 + RA,t+1 ) Lt (1 + RL,t+1 )]

t [St+1 ]
At

Lt 2
B B E
1
At
2
2 2
E + B
B E

18

Lt
Lt
1 +
Rf (1 )
B
At
At
E B

(10.10)
(10.11)

At+1 = At (1 + RA,t+1 ) pLt (1 + RL,t+1 ) and Lt+1 = Lt (1 + RL,t+1 ) (1 p)

(10.13)

Et [Rx,t+1 ] =

E [Ft+1 ] (1 p) + p
Ft

1 + E [Rx ]

t
1
1 + E [Rx ]
1p
E0 [Ft ] =
F0 + p
1p
E [Rx ] + p

(10.14)

RL,t Rf,t = (RB,t Rf,t ) + t

(10.A.1)

V = Cer(T t)

(10.A.2)
(10.A.4)

(10.A.14)

(10.A.16)

(10.A.22)

dV
dC
=
(T t)dr + rdt
V
C

Lt 2
B E B
1
At
=
2 + 2 2
E
E B
B

Lt
Lt
1 +
[Rf (1 ) + ]
B
At
At
=
E B
t

1 + x

t
1
1 + x
1p
E0 [Ft ] =
F0 + p
1p
x + p

Analysis of Financial Time Series, third edition, R. Tsay (QFIC 100-13)

Chapter 3
(3.2)
(3.3)

t = E(rt |Ft1 ), t2 = V ar(rt |Ft1 ) = E[(rt t )2 |Ft1 ]

rt = t + at , t =

p
X

i yti =

i=1

(3.4)

q
X
i=1

i ati , yt = rt 0

t2 = V ar(rt |Ft1 ) = V ar(at |Ft1 )

(p114)

a2t = 0 + 1 a2t1 + + m a2tm + et . t = m + 1, . . . , T

(p114)

F =

(3.5)

k
X

i xit

i=1

(SSR0 SSR1 )/m

SSR1 /(T 2m 1)

t = t t , t2 = 0 + 1 a2t1 + + m a2tm

(p117)

t = t t , t2 = 0 + 1 a2t1

(p118)

E(a4t ) =

(p120)

f (a1 , . . . , aT |) = f (aT |FT 1 )f (aT 1 |FT 2 ) f (am+1 |Fm )f (a1 , . . . , am |)

T
Y
1
a2
p
exp t2 f (a1 , . . . , am |)
=
2t
2t2
t=m+1

320 (1 + 1 )
(1 1 )(1 312 )

19

(p121)

(3.7)

(3.8)
(p121)

(3.9)

(p122)
(3.10)
(3.11)

T
X
1 a2t
1
2
(am+1 , . . . , aT |, 1 , . . . , m ) =
ln(t ) +
2
2 t2
t=m+1

1+

[(v + 1)/2]
p
f ( t |v) =
(v/2) (v 2)

(v+1)/2

2
t

, v>2
v2

T
X
v+1
a2t
1
2
(am+1 , . . . , aT |, Am ) =
ln 1 +
+ ln(t )
2
(v 2)t2
2
t=m+1

h i
+1
(am+1 , . . . , aT |, , Am ) = (T m) ln
ln
2
2
o
0.5 ln[( 2)] + (am+1 , . . . , aT |, Am )

)|v] if t <
/

+ 1 f [( t +

g( t |, v) =
2

f [( t +
)/|v] if t
/

+ 1

1
[( 1)/2] 2
1

, 2 = 2 + 2 1 2
(/2)

1
v
v exp 2 |x/|
, < x < , 0 < v
f (x) =
2(1+1/v) (1/v)
m
X
i h2 ( i). where h2 ( i) = a2h+ i if i 0
h2 ( ) = 0 +
=

i=1

(3.14)

GARCH(m, s) : at = t t ,

t2

= 0 +

m
X

i a2ti

i=1

s
X

2
j tj

j=1

max(m,s)

(3.15)

GARCH(m, s) : a2t = 0 +

i=1

(p132)
(3.17)

E(a4t )
3[1 (1 + 1 )2 ]
=
>3
[E(a2t )]2
1 (1 + 1 )2 212

h2 ( ) = 0 + (1 + 1 )h2 ( 1),
0 [1 (1 + 1 )
1 1 1

(p133)

h2 ( ) =

(3.22)

h2 ( ) = h2 (1) + ( 1)0 ,

(3.23)
(3.24)
(p143)
(p143)

(i + i )a2ti + t

s
X

j tj

j=1

>1

+ (1 + 1 )

1 2
h (1)

2
GARCH(1, 1) M : rt = + ct2 + at , at = t t , t2 = 0 + 1 a2t1 + 1 t1

g( t ) = t + [| t | E(| t |)]

( + ) t E(| t |) if
g( t ) =
( ) t E(| t |) if

2 2[( + 1)/2]

E(| t |) =
( 1)(/2)

t
t

0
<0

(3.25)

EGARCH(m, s) : at = t t , ln(t2 ) = 0 +

(3.26)

at = t t , (1 B) ln(t2 ) = (1 )0 + g(
20

1 + 1 B + + s1 B s1
g(
1 1 B m B m
t1 )

t1 )

+ ( + ) t1
+ ( )( t=1 )

at1

exp ( + )
t1
2

exp( )
t2 = t1
|a

t1 |

exp ( )
t1

(3.27)

(1

(p144)

B) ln(t2 )

if
if

t1
t1

0
<0

if at1 0
if at1 < 0

2
= h21 exp[(1 1 )0 ] exp[g( h+1 )]
h+1
p
h
i
2
2
E{exp[g( )]} = exp 2/ e(+) /2 ( + ) + e() /2 ( )

h21 (j 1) exp() exp[( + )2 /2( + ) + exp[( )2 /2( )

h2 (j) =

(p148)
(p148)
(p148)

Frequently Asked Questions in Quantative Finance, P. Wilmott

Q23 - Jensens Inequality (103-105)
If the payo is a convex function, E[P (ST )] P (E[ST ])

1 2 00
0

E[f (S)] = E f (S + ) = E f (S) + f (S) +

f (S) +
2
2
+ 1 f 00 (S)E[

f (S)
]
2
1
= f (E[S]) + f 00 (E[S])E[ 2 ]
2
The LHS is greater than the RHS by approximately

1 00
f (E[S])E[ 2 ]
2

Q26 - Girsanovs Theorem (113-115) The Theorem is:

Let Wt be a Brownian
motion
with
h
R
i measure P and sample space . If t is a previsible process satisfying
T
t =
the constraint EP exp 12 0 t2 < then there exists an equivalent measure Q on such that W
Rt
Wt + 0 s ds is a Brownian motion.

Chapter 6 - The Most Popular Probability Distributions

Normal or Guassian:

(x a)2
1
, < x < , = a, 2 = b2
exp
f (x) =
2b2
2b
Lognormal:

1
1 2
1
2
f (x) =
exp 2 (ln(x) a) , x > 0, = exp a + b , 2 = exp 2a + b2 exp(b2 ) 1
2b
2
2bx
Poisson:
p(x) =

ea ax
, x = 0, 1, . . . , = a, 2 = a
x!

Chi square (note that this is a generalization of the usual chi-square distribution):
f (x) =

e(x+a)/2 X xi1+v/2 ai
, x 0, = v + a, 2 = 2(v + 2a)
2i j!(i + v/2)
2
2v/2
i=0

21

Gumbel:
f (x) =

1
exp
b

Weibull:
c
f (x) =
b

ax
b

xa
b

c1

ax
1
exp e b , < x < , = a + b, 2 = 2 b2 where = 0.577216 . . .
6

2 !
xa
c+2
c+1
c+1
2
2
exp
, x > a, = a+b
, = b

b
c
c
c

Students t:

xa 2 ! c+1

2
c+1
c
2
2
b
, < x < , = a for c > 1, =
f (x) =
b2 for c > 2.
1+
c
c2
b c 2c

Pareto:

f (x) =

bab
ab
a2 b
2
,
x

a,

=
=
for b > 2
for
b
>
1,

xb+1
a1
(b 2)(b 1)2

Uniform:
f (x) =

1
a + b 2 (b a)2
, a < x < b, =
, =
ba
2
12

Inverse normal:

2 !
b
b xa
a3
2
f (x) =
exp

=
,
x
>
0,

=
a,

2x3
2x
a
b
Gamma:
f (x) =

1
b(c)

xa
b

c1

exp

ax
b

, x a, = a + bc, 2 = b2 c

Logistic

exp xa
1
1 2 2
2
b
f (x) =
xa 2 , < x < , = a, = b
b 1 + exp
3
b

Laplace:
f (x) =

1
|x a|
exp
, < x < , = a, 2 = 2b2
2b
b

Cauchy:
f (x) =
Beta:
f (x) =

2 , < x < , moments do not exist

b 1 + xa
b
ad + bc 2
cd(b a)2
(c + d)
(x a)c1 (b x)d1 , a x b, =
, =
c+d1
(c)(d)(b a)
c+d
(c + d + 1)(c + d)2

Exponential:
1
f (x) = exp
b

ax
b

, x a, = a + b, 2 = b2

Lvy:
no closed form for density function, = , variance is infinite unless = 2, when it is 2 = 2v

22