8006 Exam Dumps : Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition

A portfolio loses its delta neutrality if the delta of the portfolio changes but the underlying hedge is unchanged. The portfolio that will require the most rebalancing will be one whose delta changes by larger amounts in response to a given change in the price of the underlying. The sensitivity of the changes in delta in response to changes in the price of the underlying is measured by gamma. The higher the gamma, the more the portfolio will go out of delta neutrality given a change in the price of the underlying. Therefore Choice 'b' is the correct answer.

A portfolio with a low gamma will maintain its delta over a larger price range for the underlying, and is therefore likely to require less frequent rebalancing. The absolute level of the delta itself does not matter, what matters is the gamma. Vega is irrelevant to the delta hedging decision. Therefore the other choices are incorrect.

The price of a treasury bill can be calculated as [Future value / (1 + yield x days-to-maturity/365)] = 100/(1+5%*90/365) = $98.78.

The stock has a beta of 1.2, therefore intuitively it can be expected to earn more than the broad market index. It will earn the risk free rate, ie 3%, and 1.2 times the equity risk premium of 5% (8% - 3%). The expected returns from the stock therefore are 3% + (8% - 3%)*1.2 = 9%