Quantitative Finance Cheat Sheet

Amit Kumar Jha, UBS

Contents
1 Time Value of Money 1

2 Option Pricing Models 2

3 Portfolio Theory 4

4 Risk Measures 5

5 Stochastic Calculus 6

1 Time Value of Money

• Future Value

– Equation: F V = P V × (1 + r)n
– Variables: F V = Future Value, P V = Present Value, r = Annual Interest Rate, n =
Number of Years
– Definition: The value of a current amount of money at some point in the future, consid-
ering a certain rate of return.
– Example: If you invest $100 at an annual interest rate of 5%, the future value after one
year would be $100 × (1 + 0.05)1 = $105.

• Present Value
FV
– Equation: P V = (1+r)n

– Variables: P V = Present Value, F V = Future Value, r = Annual Discount Rate, n =

Number of Years
– Definition: The current value of a future amount of money, discounted back to the
present at a specific rate.
– Example: If you are to receive $105 one year from now and the annual discount rate is
$105
5%, the present value would be (1+0.05)1 = $100.

• Continuous Compounding

– Equation: A = P ert
– Variables: A = Amount after time t, P = Principal Amount, r = Annual Interest Rate, t
= Time in Years
– Definition: Compounding interest continuously over time.

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 – Example: If you invest $100 at an annual interest rate of 5% compounded continuously,
the amount after one year would be $100 × e0.05×1 .

sectionStatistical Concepts

• Mean
Pn
xi
– Equation: µ = i=1
n
– Variables: µ = Mean, xi = Individual Data Points, n = Number of Data Points
– Definition: The average of a set of numbers.
2+4+6
– Example: The mean of 2, 4, 6 is 3
= 4.

• Variance
Pn 2
i=1 (xi −µ)
– Equation: σ 2 = n
2
– Variables: σ = Variance, xi = Individual Data Points, µ = Mean, n = Number of Data
Points
– Definition: A measure of how spread out the values in a data set are around the mean.
(2−4)2 +(4−4)2 +(6−4)2
– Example: The variance of 2, 4, 6 is 3
= 38 .

• Standard Deviation
√
– Equation: σ = σ 2
– Variables: σ = Standard Deviation, σ 2 = Variance
– Definition: The square root of the variance, indicating the average distance of each data
point from the mean.
q
– Example: The standard deviation of 2, 4, 6 is 83 ≈ 1.63.

• Multi-Asset Variance

– Equation: σp2 = ni=1 nj=1 wi wj σij

P P

– Variables: σp2 = Portfolio Variance, wi , wj = Weights of Assets i and j, σij = Covariance

between Assets i and j
– Definition: A measure of the risk or volatility of a portfolio containing multiple assets.
– Example: In a two-asset portfolio with weights w1 = 0.6 and w2 = 0.4 and covariance
σ12 = 0.002, the multi-asset variance would be 0.62 × σ12 + 0.42 × σ22 + 2 × 0.6 × 0.4 × 0.002.

2 Option Pricing Models

• Black-Scholes Model

– Equation: C = S0 e−qt N (d1 ) − Xe−rt N (d2 )

– Variables: C = Option Price, S0 = Current Stock Price, X = Strike Price, t = Time to
Expiry, r = Risk-free Rate, q = Dividend Yield
– Definition: A mathematical model for pricing European-style options.
– Example: To price a European call option with a stock price of $100, strike price of
$100, time to expiration of 1 year, risk-free rate of 5%, and implied volatility of 20%,
you would use the Black-Scholes equation.

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• Binomial Model
PT T
1
p (1 − p)T −i max(S0 ui dT −i − X, 0)

i
– Equation: C = (1+r)T i=0 i
– Variables: C = Option Price, S0 = Current Stock Price, X = Strike Price, T = Time
Steps, r = Risk-free Rate, p = Probability of Up Move, u = Up Factor, d = Down Factor
– Definition: A model that calculates the price of an option by constructing a risk-neutral
binomial tree.
– Example: In a one-step binomial model with stock price $100, up factor 1.1, down factor
0.9, risk-free rate 5%, and strike price $100, the option price can be calculated using
the binomial formula.
• Trinomial Model
– Equation: Similar to the Binomial Model but with three possible moves (up u, down d,
or stay s).
– Variables: u = Up Factor, d = Down Factor, s = Stay Factor
– Definition: An extension of the binomial model to include the possibility of the stock
price staying the same.
– Example: Useful for pricing American options where the option can be exercised at any
time before expiration.
• Numerical Methods
– Equation: Various, such as Finite Difference Methods Vxx + Vt + rSVs − rV = 0
– Variables: V = Option Price, S = Stock Price, r = Risk-free Rate, t = Time
– Definition: Techniques for solving differential equations to find the option price.
– Example: Used when the option has features that make analytical solutions difficult.
• Heston Model
√
– Equation: Uses Stochastic Volatility dSt = µSt dt + vt St dWt1
– Variables: dSt = Change in Stock Price, vt = Volatility, Wt1 = Wiener Process
– Definition: A model accounting for volatility as a random process.
– Example: Suitable for pricing options on assets that exhibit volatility clustering.
• Merton Model
√
– Equation: Incorporates Jump Diffusion dSt = (µ − λk)St dt + vt St dWt1 + JdNt
– Variables: dSt = Change in Stock Price, J = Jump Size, Nt = Poisson Process, λ = Jump
Intensity, k = Expected Jump Size
– Definition: A model that incorporates sudden price jumps in addition to the usual ran-
dom movement.
– Example: Used for pricing options on stocks that may have large price jumps, like during
earnings announcements.
• FFT (Fast Fourier Transform)
R∞
– Equation: C(K) = e−αK π1 0 e−ui ϕ(u − α)du
– Variables: C(K) = Option Price at Strike K, ϕ(u) = Characteristic Function, α = Damp-
ening Factor
– Definition: A computational technique to price options quickly.
– Example: Useful for pricing a large number of options with different strikes or maturities
simultaneously.

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3 Portfolio Theory
• Portfolio Return

– Equation: Rp = w1 R1 + w2 R2 + · · · + wn Rn
– Variables: Rp = Portfolio Return, wi = Weight of Asset i, Ri = Return of Asset i
– Definition: The expected return of a portfolio, calculated as a weighted sum of the
individual asset returns.
– Example: If you have a portfolio with 50% in Stock A with a return of 10% and 50% in
Stock B with a return of 20%, the portfolio return would be 0.5 × 0.1 + 0.5 × 0.2 = 0.15
or 15%.

• Portfolio Variance
Pn Pn
– Equation: σp2 = i=1 j=1 wi wj σij
– Variables: σp2 = Portfolio Variance, wi , wj = Weights of Assets i and j, σij = Covariance
between Assets i and j
– Definition: A measure of the risk or volatility of a portfolio.
– Example: If a portfolio contains two assets with variances σ12 and σ22 , and a correlation
coefficient ρ, the portfolio variance would be w12 σ12 + w22 σ22 + 2w1 w2 ρσ1 σ2 .

• CAPM (Capital Asset Pricing Model)

– Equation: Ri = Rf + βi (Rm − Rf )
– Variables: Ri = Expected Return of Asset i, Rf = Risk-free Rate, βi = Beta of Asset i,
Rm = Market Return
– Definition: A model that describes the relationship between the expected return of an
asset and its risk, measured by beta.
– Example: If the risk-free rate is 2%, the market return is 8%, and the asset’s beta is 1.2,
the expected return would be 2% + 1.2 × (8% − 2%).

• Fama-French Three-Factor Model (FF)

– Equation: Ri = Rf + β1 (Rm − Rf ) + β2 SM B + β3 HM L
– Variables: SM B = Size Factor, HM L = Value Factor, β2 , β3 = Factor Loadings
– Definition: An extension of CAPM that includes size and value factors in addition to the
market risk factor.
– Example: Used to evaluate the performance of asset pricing models.

• Modigliani-Miller Theorem

– Equation: Vunlevered = Vlevered

– Variables: Vunlevered = Value of Unlevered Firm, Vlevered = Value of Levered Firm
– Definition: States that the value of a firm is independent of its capital structure in a
frictionless market.
– Example: Whether a company is financed by debt or equity should not affect its overall
value according to the theorem.

• Modigliani and Modigliani Measure (M2)

– Equation: M 2 = Rp − Rf + (Rm − Rf )

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 – Variables: Rp = Portfolio Return, Rf = Risk-free Rate, Rm = Market Return
– Definition: A measure to compare the risk-adjusted returns of various portfolios.
– Example: If a portfolio has a return of 12%, the risk-free rate is 2%, and the market
return is 8%, the M2 measure would be 12% − 2% + (8% − 2%).

4 Risk Measures
• Value-at-Risk (VaR)

– Definition: The maximum potential loss over a specific time horizon at a given confi-
dence level.
– Example: A 5% one-day VaR of $1 million means there is a 5% chance that the portfolio
will fall in value by more than $1 million over a one-day period.
– Methods:
* Historical Simulation: Looks at past data to see how badly things could have gone.
* Parametric VaR: Uses statistical models to estimate how bad future losses could be.
* Monte Carlo Simulation: Uses computer simulations to model possible future sce-
narios and estimate worst-case losses.
√
– Multi-Asset VaR Equation: VaR = w⊤ Σw
– Variables: w = Portfolio Weights Vector, Σ = Covariance Matrix

• Expected Shortfall (ES)

– Equation: ES = −E[X|X ≤ −VaR]

– Definition: Another name for CVaR, focuses on the tail risk of distribution.
– Example: Computed as the average of losses that occur in the worst 1 − α

• Credit Value-at-Risk (CVaR)

– Equation: CVaR = EL + UL
– Variables: EL = Expected Loss, UL = Unexpected Loss
– Definition: A risk measure that estimates the potential loss due to credit events, such as
default or changes in credit rating.
– Example: If the expected loss is $500,000 and the unexpected loss is $300,000, then the
CVaR would be $800,000.

• Liquidity-Adjusted Value-at-Risk (LVaR)

– Equation: LVaR = VaR + Liquidity Cost

– Definition: VaR adjusted for the liquidity of the assets in the portfolio.
– Example: If the VaR is $1 million and the estimated liquidity cost is $200,000, then the
LVaR would be $1.2 million.

• Earnings at Risk (EaR)

– Equation: EaR = Potential Change in Earnings due to Price Changes

– Definition: Measures the potential change in earnings (or cash flows) due to changes in
market variables.

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 – Example: If interest rates rise by 1%, the EaR might quantify the reduction in the com-
pany’s earnings.

• Sharpe Ratio
Rp −Rf
– Equation: Sharpe Ratio = σp

– Variables: Rp = Portfolio Return, Rf = Risk-Free Rate, σp = Portfolio Standard Deviation

– Definition: A measure for calculating risk-adjusted return.
– Example: If the portfolio return is 15%, the risk-free rate is 5%, and the portfolio stan-
dard deviation is 10%, then the Sharpe Ratio would be 0.15−0.05
0.10
= 1.

5 Stochastic Calculus
• Brownian Motion

– Equation: dWt ∼ N (0, dt)

– Variables: dWt = Change in Brownian Motion, dt = Time Increment
– Definition: A stochastic process that describes random motion, often used as a funda-
mental building block in financial modeling.
– Example: In financial markets, Brownian Motion can model stock price movements.

• Ito’s Lemma
 
∂f ∂f 1 2 2 ∂2f ∂f
– Equation: df (t, St ) = ∂t
+ µSt ∂S t
+ 2
σ St ∂S 2 dt + σSt ∂S t
dWt
t

– Variables: f (t, St ) = Function of Time and Stock Price, µ = Drift Rate, σ = Volatility, St
= Stock Price at Time t
– Definition: A fundamental theorem in stochastic calculus.
– Example: If f (t, St ) = St2 , then using Ito’s Lemma we can find df (t, St ).

• Geometric Brownian Motion (GBM)

– Equation: dSt = µSt dt + σSt dWt

– Variables: dSt = Change in Stock Price, St = Stock Price, µ = Drift, σ = Volatility, dt =
Time Increment
– Definition: A stochastic process that is often used to model stock prices.
– Example: Used in the Black-Scholes formula for option pricing.

• Jump Diffusion

– Equation: dSt = µSt dt + σSt dWt + dJt

– Variables: dJt = Jump at Time t
– Definition: Extends GBM by including jumps in the stock price.
– Example: Used for modeling stock prices that can experience sudden, significant changes.

Thank You