(Papers) ACET Paper June 2015 "ST6 – Finance and Investment B"

Q.3
a)

i) State (without derivation) the partial differential equation derived from Ito’s lemma that is satisfied by the prices of derivatives in a Black-Scholes world, defining the variable concerned. [3]
ii) State the main assumptions underlying this equation. [3]
iii) State the issues relating to s when this model is used in practice and how these are addressed. [3]
b) State the main constraints on the behaviour of a stock price for Ito’s lemma to be applicable.