PAPER CODE NO. EXAMINER: Dr. J. Yslas Altamirano, TEL.NO.

MATH 377 DEPARTMENT: Mathematical Sciences

MOCK FINAL EXAM - II

Financial and Actuarial Modelling in R

Time allowed: 120min

INSTRUCTIONS TO CANDIDATES:

All answers will be taken into account. The marks noted indicate the relative
weight of the questions out of 70 marks in total.

By submitting solutions to this assessment you affirm that you have read and
understood the Academic Integrity Policy detailed in Appendix L of the Code
of Practice on Assessment.

Note that this mock paper is designed to show you the style of the final exam.

Paper Code MATH 377 Page 1 of 5 CONTINUED

 1. Consider the following joint distribution for the returns on two stocks, A
and B:

Probability Return on Stock A (RA ) Return on Stock B (RB )

0.3 -10% 5%
0.2 20% 15%
0.3 10% -5%
0.2 30% 20%

(a) Find the mean and standard deviation of a portfolio such that the weight of
stock A is 43% and the weight of stock B is 57%. [5 marks]

(b) Write an R program that plots the opportunity set available to any investor.
[3 marks]

(c) Write an R program to plot the capital market line if the risk-free rate is 4%.
[3 marks]

(d) Write an R program to find the minimum variance portfolio. What is the
expected return of this portfolio? [3 marks]

2.

(a) The price of a stock is currently 15. Over each of the next four 2-month
periods, it is expected to increase by 5% or decrease by 4%. The risk-
free interest rate is 3.5% per annum with monthly compounding. Write
an R program to find the initial price of an 8-month derivative that pays off
− min(0.5 · (S(T ))2 − 100, 0) [6 marks]

(b) Consider a European Call option over a stock with a current price of S(0) =
200 and volatility of 0.33. If the risk-free interest rate with quarterly com-
pounding is 7% per annum, the strike price is 188, and the time to maturity
of the option is 6 months:

(i) Find the price of the option using the Black-Scholes formula. [3 marks]
(ii) Find the Greeks for the option. [2 marks]
(iii) Plot rho (ρ) against the initial stock price for S(0) ranging from 100 to
300.
[3 marks]

Paper Code MATH 377 Page 2 of 5 CONTINUED

 3.

(a) Let X = (X1 , X2 ) be a bivariate normal distributed random vector with mean
vector µ = (5, 3) and covariance matrix
󰀕 󰀖
3 2
Σ=
2 5

(i) Compute P(X1 > 3, 0 ≤ X2 < 4). [3 marks]

(ii) Generate a sample of size 2500 from X to approximate the 5% quantile
of X12 |X2 |. [2 marks]

(b) Consider an arithmetic Brownian motion with a drift of 0.75 and volatility
of 0.12:

(i) Perform 5000 simulations of this process to approximate the probability

that the process is below 3 at time 4. [3 marks]
(ii) Compare the above result with the corresponding theoretical probabil-
ity. [2 marks]

Paper Code MATH 377 Page 3 of 5 CONTINUED

 4. Consider the collective risk model
N
󰁛
S= Xi ,
i=1

where N is Poisson distributed with mean λ = 2.5.

(a) Let X be a discrete random variable with density function given by fX (1) =
fX (2) = 0.2 and fX (4) = fX (6) = 0.3. Find P(S ≤ 0.2E(S + 1)). [4 marks]

(b) Let X ∼ W eibull(2.5, 3.5). Recall that the density function of a W eibull(α, λ)
distributed random variable is given by

󰀓 α 󰀔 󰀓 x 󰀔α−1 󰀓 󰀓 x 󰀔α 󰀔
f (x) = exp − , x ≥ 0.
λ λ λ
(i) Plot the original distribution function of X along with its discretized
version over (0, 10) using the upper discretization method with a step
of 0.1. [4 marks]
(ii) Using the previous discretized version of X, find P(3 < S ≤ 8) via
Panjer’s recursion. [4 marks]
(iii) Simulate a sample of size 1000 from S to approximate the Coefficient
of Variation (CV) of S. [4 marks]

Paper Code MATH 377 Page 4 of 5 CONTINUED

 5.

(a) Consider the classical surplus process

N (t)
󰁛
U (t) = u + ct − Xi , U (0) = u > 0,
i=1

where N (t) is a Poisson process, with parameter λ representing the number

of the claims and {Xi }i≥1 are i.i.d. random variables, independent of N (t).
The density of the claim amounts is given by

3 log(2) − log(2)x
fX (x) = e + e−4x , x ≥ 0.
4
Also, you are given that the intensity of the Poisson process is λ = 3, and
the premium received per unit of time is c = 5.

(i) Write an R program to plot the exact ruin probability as a function of

u ranging from 0 to 10. [4 marks]
(ii) Find an upper bound of the ruin probability for u = 2. [4 marks]

(b) Consider the above classical risk model under excess-of-loss reinsurance. Sup-
pose that the relative security loading of the company in a reinsurance-free
environment is θ = 15% and that the relative security loading under excess-of-
loss reinsurance is θh = 30%. Write an R program to plot the risk adjustment
coefficient as a function of the retention limit m ranging from 1 to 6.
[8 marks]

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