Can anyone explain why question 1(ii)(a) has used discounted RPI and strike price in the log part of: ? In every other example of using Black's model, or the Garman-Kohlhagen formula, the ratio inside the log has always been values at expiry of the option, never the discounted values. So i'm a little confused...
wouldnt separation of the Log in this case reduce to a typical Black Scholes/garman kohlagehn looking d1/d2 formula i would have thought the same was in the usual black formula where all is parametrised in terms of forward prices F which are put inside logarithm, but as F = S * exp (rt), for stocks, this reduces to typical d1/d2 found in black scholes/ gk formulae...
i dont know, couldn't you argue that share prices or RPI indicies are effectively similar, so if you don't discount the share price, then why should u discount the RPI index? Still unconvinced
ST6-11 says the ratio inside the log is: E[V_T] / X where X is the strike price and V_T the payoff of the option. These are NOT discounted. I'm feeling reasonably confident the examiner is wrong.
gareth i have seen a few cases where in d1 formula, ratio inside logarthim includes discounted strike... look at brearley and myers "principles of corporate finance " fifth edition page 578 look at d1 expression, the ratio inside logarithm has pv(EX)...and no r in the rest of the expression for d1. algebraically under continuous compounding this should equal conventional formuale for d1( i.e no discounting in teh log ratio with r shoved into the second bit of d1 numerator )
