Deck 21: Forward Risk Neutral Pricing and the Libor Market Model

Question 1

What underlying assumption is there in any form of the Fundamental Pricing Equation?

Answer 1

It assumes that there is a sufficent number of traded securities in order to create the riskless portfolio.

Question 2

What is a forward risk neutral process?

Answer 2

A forward risk neutral process is a risk neutral process that has been
normalized by dividing it by another interest rate security.

Question 3

What does the change in numeraire technique accomplish?

Answer 3

Question 4

What is the only input needed for pricing securities under the Heath- Jarrow-Morton framework?

Question 5

How strong is the consistency among prices for different securities, when using different numeraires?

Question 6

What complications arise when computing for interest rate derivatives such as options?

Question 7

What is the only restriction that the Heath-Jarrow-Morton framework impose?

Question 8

From where does the change in numeraire technique get its name?

Question 9

Given forward risk neutral dynamics, what can be said of a forward price?

Question 10

In order to obtain forward risk neutral dynamics, must we always use zero coupons?

Question 11

What does the Feynman-Kac formula say on pricing securities?

Question 12

What requirement must a numeraire ful?ll?

Question 13

What are the two important differences in the Fundamental Pricing For- mula, when applying the change of numeraire technique?

Question 14

In the most literal sense, are Heath-Jarrow-Morton type of models short- term models?