Tomorrow’s midterm exam in Finance 4366 consists of 2 sections. The first section is required of all students and consists 4 multiple choice problems 8 points each. The second section is worth 64 points; it consists of 3 problems in which only two are required. At your option, you may complete all three problems, in which case I will count the two highest scoring problems (worth 32 points each). The maximum possible score on this exam is 100 (96 points possible for sections 1 and 2 and 4 points for including your name on the exam booklet :-)). Furthermore, I just posted the formula sheet for Midterm Exam 1, which will be included as part of the exam booklet. I recommend that y’all familiarize yourselves with this document sometime prior to tomorrow’s exam.

I’d like to make an important point about the formulas provided on the formula sheet for the replicating portfolio approach to option pricing. There, I list replicating portfolio values at inception and at expiration. Keep in mind that this approach involves determining a weighting scheme such that one replicates call or put payoffs by appropriately choosing stock exposure (delta) and bond exposure (beta). At this point in the course, we only allow for two possible option payoffs at expiration; thus, there actually are two equations for the replicating portfolio at expiration. These equations reflect the fact that the value of the underlying asset is different in each possible terminal state. However, since she value of the underlying asset is known at the inception of the option, there is only one equation for the replicating portfolio at that point in time.