MSc/Diploma in Mathematical Finance—2010 for 2011 entry

Admissions Test

You should attempt all questions and show all working: stating the answers without show-
ing how they were obtained will not attract credit. [Note: Some questions taken from
Oxford Honour Moderations and Final Examinations in Mathematics.]

1. For the following matrix, find all eigenvalues and all (normalised) eigenvectors:
 
4 −2 2
A =  −2 3 0.
 

2 0 5

Use this to calculate the matrix exponential eA .

2. (a) Evaluate
Rπ
– 0 sin2010 x dx

– x3dx
R
+1
R x2 /2 2
(b) Find the second derivative of f (x) = −∞
ex−t /2
dt.

(c) Derive the solution of the ordinary differential equation

d2 y dy
= f (x), x > 0, y(0) = 0, (0) = 0,
dx2 dx
in the form Z x
y(x) = (x − t)f (t) dt.
0

3. Suppose that x and y are related to u and v by

sin u sin v
x= , y= . (∗)
cos v cos u

(a) Show that

∂u cos3 v cos u
=
∂x cos(u + v) cos(u − v)

MSc/Diploma in Mathematical Finance -1- Admissions Examination 2010

 ∂u ∂v ∂v
and find similar expressions for , and .
∂y ∂x ∂y
(b) Show that
1 − x2
cos2 u =
1 − x2 y 2
and give a similar expression for cos2 v. Deduce that the given relation (*) defines a
bijection between the regions

{(x, y) | 0 < x < 1, 0 < y < 1} and {(u, v) | u > 0, v > 0, u + v < π/2} .

and evaluate the integral

1 1
1
Z Z
dx dy .
0 0 1 − x2 y 2

(c) Expanding (1 − x2 y 2 )−1 in positive powers of x and y, and assuming it is valid to

exchange the order of integration and summation, deduce that
∞
X 1 π2
= .
(2k + 1)2 8
k=0

4. (a) Find all solutions of

d2 y dy
2
+2 + 2y = ex .
dx dx

(b) Verify that y(x) = x−2 is a solution of

d2 y dy
x 2
+ (3 − x) − 2y = 0,
dx dx
and so find the general solution. Determine the solution which satisfies the boundary
conditions y(1) = 0 and y(2) = 1.

(c) By making the substitution t = ex and setting z(t) = y(x), rewrite the differential
equation
d2 y dy
2
− + e2x y = xe2x − 1,
dx dx
as one in terms of z and t. Hence find all solutions.

5. (a) Find and classify the critical points of

f (x, y) = sin x sin y sin(x + y) (0 ≤ x, y ≤ π).

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 (b) Show that the function

g(x, y) = x4 + 6x2 y 2 + y 4 − 4x3 − 12xy 2 + 6x2 + 6y 2 − 4x + 1

has a critical point on the x-axis and locate it. Show that all three second derivatives of
g(x, y) vanish at this point, and find whether it is a maximum, minimum, or saddle point.

(c) Use Lagrange multipliers to find the minimum value of f (x, y, z) = 4x2 + 4y 2 + z 2
subject to x2 + y 2 + z 2 = 1.

6. Let f (t) be defined for t > 0, let

Z ∞
f¯(p) = e−pt f (t) dt
0

be the Laplace transform of f , let g(t) = f ′ (t) and let h(t) = tf (t). Derive formulae for
the transforms ḡ and h̄ of g and h in terms of f¯.
1
Show that if f (t) = t− 2 then
π
r
f¯(p) = ,
p
√
and hence find the transform of t.

Let u(x, t), defined for x > 0 and t > 0, be the solution of the heat equation

∂2u ∂u
2
=
∂x ∂t

which satisfies the conditions

∂u
u(x, 0) = 0, (0, t) = −1, u(x, t) → 0 as x → ∞,
∂x

and let Z ∞
v(x, p) = e−pt u(x, t)dt.
0

∂2v ∂v
Show that ∂x2 = pv and ∂x (0, p) = − p1 , and

v(x, p) → 0 as x → ∞.

Hence find v(x, p) and u(0, t).

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7. Find the solution of the problem

∂u ∂2u
= , u(0, t) = 0, u(π, t) = 0
∂t ∂x2
u(x, 0) = sin2 (x), 0 < x < π.

Also find the solution for the initial condition

∂u
(x, 0) = sin2 (x), 0 < x < π.
∂t

8. Consider the heat equation

∂u ∂2u
= .
∂t ∂x2
√
Show that if u(x, t) = tα φ(ξ) where ξ = x/ t and α is a constant, then φ(ξ) satisfies the
ordinary differential equation
αφ − 21 ξφ′ = φ′′ ,

(where ′ ≡ d/dξ). Show that

Z ∞ Z ∞
u(x, t) dx = tα φ(ξ) dx
−∞ −∞

is independent of t only if α = − 21 . Further, show that if α = − 12 then

C − 12 ξφ = φ′

where C is an arbitrary constant. From this last ordinary differential equation, and as-
suming C = 0, deduce that
A 2
u(x, t) = √ e−x /4t
t
is a solution of the heat equation (here A is an arbitrary constant).

Show that as t tends to zero from above,

1 2
lim √ e−x /4t = 0 for x 6= 0
t→0+ t

and that for all t > 0 ∞

1
Z
2
√ e−x /4t dx = B
−∞ t
R∞ 2 √
where B is a (finite) constant. Given that −∞ e−x dx = π, find B.

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 What physical and/or probabilistic interpretation might one give to this solution u(x, t)?

9. In a certain country two candidates compete at a presidential election. The candidate with
the most votes will win. For an opinion poll just before the election, n voters have been
sampled randomly from the large voting population. Of these, nj said they would vote for
candidate j = 1, 2, where n1 +n2 = n. Denote by p the proportion of the population voting
for candidate 1, who is in fact the current president. [You should ignore the possibility of
undecided voters and of voters changing their mind or lying for the poll.]

(a) Explain how the above opinion poll data can be related to independent Bernoulli(p)
random variables B1 , . . . , Bn . Find the maximum likelihood estimator p̂ of p.

(b) Show how Var(Bi ) depends on p, writing it as a function σ 2 (p). Assuming that it
is valid to estimate σ 2 (p) by σ 2 (p̂), use the CLT to construct an approximate symmetric
100(1 − α)% confidence interval [L, R] for p. Show that [L, 1] is then an approximate
100(1 − α/2)% confidence interval for p.

(c) Suppose that [0.503, 1] is the approximate 95% interval estimate for p resulting from
the poll. Interpret this for someone with no statistics background and explain what this
means for the re-election of the current president.

10. Consider a random walker on {0, 1, 2} who moves as follows:

– if at 0, there is probability 1/2 each of staying at 0 and moving to 1;

– if at 1, there is probability 1/2 each of moving to 0 and moving to 2;

– if at 2, there is probability 1/2 each of moving to 1 and staying at 2.

Denote the location of the random walker after k steps by Xk . Let X0 = 0.

(a) Let N be the number of steps until the first visit to 1. Consider pk = P (N = k) and
qk = P (Xk = 1).

(i) Without any calculations, explain why pk ≤ qk for all k ≥ 0.

(ii) Calculate pk and qk for all k ≥ 0.

(b) Calculate the joint distribution of (X2 , X3 ) and show that X2 and X3 are not inde-
pendent. For what values of k ≥ 0 are Xk and Xk+1 independent? Give reasons.

11. (a) Let X and Y be random variables with (X, Y ) uniformly distributed on the circular

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 disk D = {(x, y) : x2 + y 2 ≤ 1}. Write down the joint probability density function of
(X, Y ). Random variables R and Θ, with 0 ≤ R ≤ 1 and 0 ≤ Θ < 2π are defined by

X = R cos Θ, Y = R sin Θ.

Find the joint probability density function of R and Θ.

Hence, find the probability density function fR (r) of R, and show that Θ is uniformly
distributed. Find the expected value E(R) of R. Are R and Θ independent?

(b) Consider two independent random variables X and Y , uniformly distributed on the
interval [−1, 1]. A random variable Z is constructed by drawing samples from X and Y ,
and forming X 2 + Y 2 , however disregarding any draws that give X 2 + Y 2 > 1. Show that
Z is uniformly distributed on [0, 1].

12. Let {Xk } be a sequence of independent random variables whose corresponding cumulative
distribution functions {Fk } are continuous and strictly increasing. Let
n
1 X
Zn = − √ (1 + log(1 − Fk (Xk ))) , n = 1, 2, . . .
n
k=1

Show that, as n → ∞, {Zn } converges in distribution to a normal distribution with mean

zero and variance one.

13. Let X and Y have a bivariate normal distribution with correlation ρ.

(a) Show that X and Y are normally distributed, and find their mean and variance.

(b) Show that X + Y is normally distributed, and find its mean and variance.

(c) Show that the conditional density of X given that Y = y is normal, find its mean and
variance.

14. Let (Nt )t≥0 be a Poisson process of rate λ, and let Xn , n ≥ 1, be the corresponding inter-
arrival times. State the joint distribution of Xn , n ≥ 1, and find the moment generating
function of X1 . Suppose Nt denotes the number of tourist coaches arriving at Blenheim
Palace by time t.

(a) Suppose the probability that each coach is white is p, independently of the colours
of all other coaches. Let T denote the arrival time of the first white coach. By writing T as

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 a sum of independent identically distributed random variables, find the moment generating
function of T and deduce the distribution of T .

(b) Suppose the number of tourists on the nth coach is Yn , where Yn , n ≥ 1, are
independent identically distributed random variables and independent of Nt , each with
moment generating function MY . Let Zt denote the total number of tourists arriving by
time t. By writing Zt as a sum of independent identically distributed random variables,
show that
E(eθZt ) = exp[λt(MY (θ) − 1)]

and find E(Zt ) and var(Zt ).

p
Let Ut = (Nt − E[Nt ])/ var(Nt ). Find the moment generating function of Ut . Deduce
that Ut converges in distribution as t → ∞ and determine the limiting distribution.

15. A group of n players is divided into two teams (a red and a blue team) according to the
following procedure.

First a number X is chosen randomly from the set {1, 2, . . . , n − 1}, with all values equally
likely. Then X of the n players are chosen to form the red team, with all possible sets of
size X equally likely. The remaining n − X players form the blue team.

(a) Find the mean of the size of the red team.

Consider one particular player, called Player A.

(b) Find the probability that the team containing Player A has size k for 1 ≤ k ≤ n−1.

(c) Find the mean of the size of the team containing Player A.

After the teams have been chosen, each team selects a captain, who is equally likely to be
any member of that team.

(d) Find the conditional distribution of the size of the team containing Player A, given
that Player A is the captain.

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